There are many good companies that I would like to invest in, and there are some companies that I would stay away from. Social media is an industry that has always been a red flag for me. There really hasn’t been a company that has separated itself from the rest in regards to its services. The following companies are tied closely together, and I still have my concerns on whether they are a good investment.
For those of you that have read or listened to Warren Buffett, you are well aware of his stance on companies needing a durable competitive advantage. He is adamant about investing in companies that are doing something nobody else can/will/is doing. Even if other companies are doing the same thing, is there really any hope of them catching up with the industry leader? If so, he likely wouldn’t invest in it.
Yes, Facebook Inc (NASDAQ:FB) has nearly 1 billion users, but does it offer anything different than its competitors? Other forums such as Google +, Twitter, and LinkedIn, offer similar products/services for free. More and more people are joining these other sites daily, but Facebook Inc (NASDAQ:FB) still manages to grow — at least for now. Let’s look at reality for a second. Besides having more users than its competitors, how does it separate itself from the rest of the industry? Now, I know Facebook made a historically bad impression with its IPO, but it may actually be in a better position now.
With $1.97 billion of revenues in 2010, the company may see revenues triple by the end of this year. However, the company shows a dismal FCF yield of just .62%. Not exactly the type of investment a bargain hunter would enjoy. I know, that is only one metric. However, Facebook’s earnings per share (EPS) are as close to zero as you can get despite showing .43 in 2011. The stock plummeted after its IPO, rebounded, but has fallen again. It’s down nearly 33% over the past year and nearly 4% YTD.
One company that is tied very closely to Facebook’s success is Zynga Inc (NASDAQ:ZNGA). Zynga Inc (NASDAQ:ZNGA) is dependent on social media companies (and other companies of that sort) to survive. They use these sites to market gaming products. This isn’t exactly the largest durable competitive advantage I’ve seen in my lifetime. Zynga needs help, but where should they look?
They bought OMGPOP after one of its games (Draw Something) had gone viral. In fact, there were reports that Draw Something was selling over $250,000/day in new color palettes and game upgrades. That’s over $91 million a year. Zynga Inc (NASDAQ:ZNGA) only paid $183 million for the entire OMGPOP company. This was a good move, right? Almost immediately after the purchase, Draw Something’s popularity not only stopped growing, but fell off. It’s not the only thing that fell off, as Zynga Inc (NASDAQ:ZNGA)’s stock has fallen from $13.71/share at the time of the purchase, to just over $3 today.
While Zynga Inc (NASDAQ:ZNGA)’s revenues have increased more than ten-fold since 2009, they have remained practically level over the past year. Since 2009, gross margins have increased annually, but its EPS has been in the negative since 2011. The company also has a negative FCF and a stock that has fallen nearly 58% in the past year. YTD the stock is up over 42%.
The Foolish Conclusion…
Despite its efforts, Zynga Inc (NASDAQ:ZNGA) is not showing a whole lot of promise for long term investors. It is dependent on companies like Facebook that are not performing well themselves. I think both of these companies could Draw Something up and find more production. They both lack durable competitive advantages, and certainly don’t show the value needed for bargain investors. Growth investors may see something different, but for me, there is too much risk and too little upside to invest in these companies at this time.
The article Zynga Needs to Draw Something… originally appeared on Fool.com and is written by Tyler Wofford.
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