Why I won't buy facebook at $100B Valuation

According to news reports facebook will be filing an application with SEC for an IPO early next year which might value the company around $100 billion dollars. Before this number came out, I was anxiously waiting for a facebook IPO. I also tried to buy facebook shares through a secondary market but transactions  costs and volumes required to buy in such markets are prohibitively high, preventing people like me from trading in such markets.

That being said, the real issue I have now is facebook's valuation of $100B. Before we determine valuation of facebook, lets look at the current value of other technology giants, their growth opportunities and risks.

I am going to use Market capitalization for these companies at current share price as approximate firm's value. Enterprise value in each case is little less. Firm's value if calculated in each case should come around its Market Cap with the exception of Amazon in my opinion which I believe is valued much higher by the market.

To start with, let's look at Apple. It's the second most valuable company in the world and is valued at $346B at the time of this writing. Market for whatever reason is not anticipating high growth in Apple, which is reflected in its little over 13 P/E ratio. But in my personal opinion, Apple still has a bright future and it is going to grow in foreseeable future at the same rate as it has done in the last decade. I don't need to go into details about Apple's stream of revenue but we know that it offers a diverse set of products and continues to create new markets (for example from IPod to IPhone to IPads. Now prediction is they will revolutionize TV industry). Given my level of expertise, I cannot predict where Apple would be in next ten years but in my humble opinion market is undervaluing Apple at $346B. The biggest risk in investing in Apple at this point is the fact that Steve job's is gone and company needs to prove that it can be just as successful without its visionary founder.

Another similar tech giant is Google. Google is currently valued at $188B. Based on its P/E ratio of 19, we can say that market is expecting Google to grow faster than Apple. Given the diversity of its Products and Services, Google is in a solid position and in my personal opinion its market valuation, reasonably reflects its fair market value. Again Google's revenue stream mainly consists of online advertising revenue, but Google has successfully diversified revenue sources by acquiring youtube, double click and by launching a successful Smartphone operating system Android.

Third tech giant that I would consider is Amazon. Amazon is currently valued at $85.7B while trading at a P/E ratio of over 99. That is huge. Market apparently is expecting a lot of growth in Amazon. In my personal opinion nothing can justify a P/E ratio of 99 unless a company had a particular quarter where it took a huge one time charge, for either acquisition or for any other reason. This however is not true for amazon. In fact, before this quarter's results, Amazon was trading at a P/E ratio of over 120 which in my opinion, in no way, justifies the underlying value of the company. If reader's followed Netflix, they should know by experience, what happens to their investment in companies that are valued so ridiculously high. As for Amazon's revenue stream, we know that its the largest online retailer. Amazon also owns Zappos. Besides it's Kindle book reader, Amazon has recently also entered the tablet market with its new Kindle fire. As Amazon itself calls a technology company rather than a retail company, Amazon has also entered into cloud computing space to increase and diversify its source of revenue stream.

After discussing these three giants, let's look at facebook. Majority of its revenue at this point comes from online ads and some from virtual currency sold on facebook. As for risk to facebook's business, I think people have adapted to facebook and there is a network effect which will make it very difficult for any competitor to come in and beat facebook in social networking. Google has tried it multiple times with Google Plus being its latest attempt, but so far it has failed. I have already written about it and in my opinion Google plus will fail until some privacy policies are drastically changed. That being said, if there is another revolutionary idea that will change how people use internet (it has happened before with facebook being one such revolution), then facebook in its current state stands to lose most. This risk factor and the fact that its revenue stream is not as diversified as other technology giants I discussed above, I think facebook's valuation at $100B is too high, specially when compared to valuation of other tech giants. Unless you are a speculator who is trying to make a stag profit, I think you should stay away from buying facebook at such a high value.

Zappos - 365 Day Price Match Policy

One thing common among great companies is that they don't compete on prices. Competing on prices will mean that there is a high chance that someone will match it and worse beat it. So no, Zappos which I believe is a great company does not offer price match with its competitors. However, if the price of the item you purchased from Zappos went down during one year on Zappos website, they will match it, or rather I should say that it is in their best interest to match that price if a customer requests. I purchased a suitcase last month from Zappos for $207. Just yesterday, I was browsing the website and noticed that the suitcase I paid $207 for is now selling at $142. That's a $65 difference in less than a month. I contacted their live chat agent and she told me that their price match policy is only for 10 days but she'll do it once for me as a courtesy. I appreciated but reminded her that by virtue of Zappos 365 day return policy which included free shipping both ways, they are effectively offering a 365 day price match policy too. She disagreed and I had to explain her that if she refuses to price match in future, I'll simply order the same thing again, won't even open it when it arrives and then send it back with my previous orders receipt as if I was returning the original product that I might already be using. This will get me my price match and will cost Zappos extra money in shipping. Unless Zappos can find a way to tag every single item, they cannot differentiate between two similar pair of shoes or bags or anything. This will require an RFID tag which can be very costly (about 10 cents per item) and will also fly against their practice of exceptional customer service. So, in my opinion, Isabella, you are better off matching that price every time a customer requests as long as it is within 365 days, otherwise you'll end up with an unhappy customer who will figure out a way to get the price match and Zappos will end up losing price match amount plus two way shipping charges.

Stock market is doing great...well may be

This was on Google news today.

In Case of US Default

As congress fails to agree on a plan to increase government's borrowing limit, chances of US government defaulting are increasing everyday. Everyone is saying that it is going to be catastrophic. Paul Krugman said if it happens then it is going to be "1937 squared". Although market's are down but they have not collapsed and that's because market still believes the probability of default is low. So market is currently multiplying the probability of default to the impact of default and calculating new prices. Now this probability increases everyday bringing market's down slowly. When and if US government defaults, we'll see the impact because then this probability will be 100 percent.

Like most people who love Economics I have been thinking about the potential impact. So let's start from scratch. When US government defaults, its credit rating will go down. This means any future borrowing will be expensive. There are institutions who are required to hold only AAA rated bonds for their investments. They will have to sell US treasury bonds to buy other AAA rated securities. This will derive the the prices of AAA securities up and reduce their current yield. This means that institution who are required to hold AAA securities will make less money. How are they going to respond? That's a difficult question but just hope that some genius does not come out with something like "mortgage back securities" and hope that rating agencies don't assign it AAA ratings. That being said, if US government defaults, vendors will not be able to get the money. It will also reduce its spending which in turn means that several companies who rely on US government as a major customer will be at risk. Stock prices for such companies will go down due to expected lower earnings and it will create a ripple effect tanking the stock market and economy. Investors will buy gold since US dollar is no more a safe haven and we'll see a rise in already overly priced gold.

What's next for Zappos

Zappos is one of my favorite companies. In 2009 I purchased a pair of shoes from Zappos. The reason I chose Zappos at the time was the variety that they had. Before my purchase, I went to Macy's, Von Maur and was not able to find anything that I liked. When I searched online, I found Zappos and I was amazed at the collection. I noticed that their prices are same as what you'd pay at a brick and mortar store except that their collection is huge. Shipping is free on both sides and so I decided to try them. After spending a lot of time going through the selection, I ordered a pair of shoes. I used free standard shipping option. A day later I had my shoes delivered with a thank you note that said that they bumped my shipment to free overnight. I was amazed. I loved my shoes and became a zappos fan.

Last month I read Tony Hsieh's (pronounced Shay) "Delivering Happiness". First half of the book is very exciting where Tony has described the challenges Zappos faced as a young company and how they survived. I love risk takers and so I loved Tony's story about Zappos. Its a great example of passion combined with the fact that big achievements requires taking substantial risks.

Today on facebook, Zappos asked, what business should they enter next. For those who don't know, Zappos is already selling Shoes, clothing, bags (best selection again anywhere to be found in my opinion), sporting goods, eyewear, jewelry, watches and fashion accessories. Now million dollar question is what should be next? Remember, they don't sell cheap stuff. What differentiates Zappos is their customer service. If you are a Starbucks customer and haven't purchased anything from Zappos yet, then I must tell you that Zappos is the only company that matches a  customer service experience that you get at Starbucks in my opinion.

I am not going to buy books from them because I can get virtually any book I want to read from amazon and they are cheap. By the way, in case you don't know amazon owns zappos. Similarly I don't think I'll buy electronics from them as there are too many alternatives. That's why I believe (and may be I am wrong) that their housewares business is probably not very profitable. I think so because "Bed, Bath and Beyond" is a good alternative. Remember one of the reasons I am willing to pay them extra is because of their collection and I think in these areas there are many companies that are offering a huge variety and at a price lower than Zappos.

In my opinion the next big thing for them could be "Home Decor". I went to Europe last year for a vacation with my wife and kid. One of the cities we visited was the beautiful Italian city, Venice (Venezia). Besides the fact that its a beautiful city and you should go there if you ever go to Europe, one thing that me and my wife agreed was when we have our own house, we'll go back to Venice, just for shopping. You simply won't find the kind of glasswork they have anywhere else. Glasswork is not the only thing you'll find in Venice (and I am assuming its true for all of Italy). They have hand crafted wooden objects for home decor and again something difficult (definitely not impossible) to find in US.

In my opinion Zappos can bring these to American consumers. They don't have to be only from Europe. Zappos can get things that are only available in Far East, South Asia and other places in the world and supply them in US market. One thing that should be unique is a huge variety and little competition. I think we still don't have a big online store or even a brick and Mortar store that sells a huge variety of Home Decor. There are several smaller ones but it is difficult to find everything under one roof and that's where in my opinion an opportunity exists for Zappos. Search cost for consumers is high because of an absence of major player in this market and Zappos can provide value by reducing their search cost by providing a huge variety under one roof.

One of the biggest challenges in extending business in 'Home Decor' sector is the fragility of most Home Decor objects. One possible solution is to open a brick and mortar store but they don't  have any experience or expertise in running a brick and mortar store.

It's a difficult question to answer and I have to leave or I'll miss my train so I'll let Zappos figure out how to overcome this challenge.

Why Should I Use Google +

Just received an invite for Google +. Privacy policy is no better than facebook. To join I must accept that google will integrate all my pictures from Picasa. Or I can't join. Why should I use Google +? To effectively use Google + I would need to adapt myself to a new user interface. I will also have to wait for most of my friends to switch unlike Gmail which I could have used regardless of my friends using Gmail or not.

The only positive about google + when compared to facebook is that you can delete your account as opposed to "inactivate" on facebook. People are currently rushing to see Google + out of curiosity and the fact that they feel privileged as you can only join Google + by invitation. I think its going to be interesting to watch how the product will going to turn out. Let's wait and see. In my lowly opinion, its going to fail unless privacy policies are better than facebook. Even then people will be skeptical of google as it currently retains user's google searches for 7 years. But in my opinion, a better privacy policy is the only way to compete against facebook.

Google's Strategy for Google+

So Google announced Google + two days ago as a facebook competitor. One reason of facebook success is the network effect that it creates. For example, initially when  I joined facebook, I had only 10 friends for first 1 month. But in last two years, as more people started to join facebook, I have little over 100 friends. If I want to switch to a different social network, then not only I have to switch to Google +, but I would also want most of my friends (at least around 50) to switch to Google +. To break this network effect and encourage more users to use Google +, Google is using a known strategy of scarcity. You and I cannot create a new account on Google + because we don't have an invite. It's making a lot of people curious. People are curious to see what's so special about it. Specially when one of the friends on their facebook account posts a positive review of google +. So google is first creating curiosity among the end users of Google + and once the product has received enough publicity, Google will probably use the same strategy as it used with Gmail. Current Google+ users will be allowed to invite x number of their friends. They in turn can invite another x number and so on.

I think it is a great strategy and based on the product's features, facebook  can now have a formidable competitor with deep pockets and a  talented engineering team. But unlike Gmail, success of Google + will depend on substantial number of people switching to create the network effect.

One thing that I would do (I know Google won't) to lure users to new Google + is have a better privacy policy. For example, I would advertise that if you delete your account, your data is gone (unless required by law). Similarly, if Google can differentiate itself on other privacy policy terms from facebook then definitely people will have a good reason to switch. I know data is very precious and Google would decide to keep it. But in my opinion if they hit facebook on its Achilles heel, that is, privacy, then Google + will have a better chance of success.

From economics perspective, isn't it great to see competition at work? I don't know about you but I love these "Greedy Capitalist Pigs". In their quest of making more money (they call it being successful) they give this world newer and better products and services at lower prices. Be it Google + or facebook, or iOS or Android or Windows Phone 7, us consumers are better off.