Mark Zuckerberg

What bearish investors are missing about Facebook

January 8, 2014: 2:44 PM ET

Investors who are worried about Facebook's latest equity offering are overlooking the company's fundamentals.

By Sanjay Sanghoee

131004135401-facebook-620xaFORTUNE -- Shortly after Facebook's recent announcement of a new public offering worth $1.5 billion, for which Mark Zuckerberg provided 60% of the shares, Facebook stock fell amidst concerns that it is overvalued. The shares rebounded on optimism about social media, but it is a safe bet that such doubts will continue to plague the company in 2014.

But the market may be missing the bigger picture.

In terms of the new offering and particularly Zuckerberg's role in it, even visionary founders are entitled to monetize their ownership over time, and so this may not be a signal of anything sinister. Besides, the shares being sold by Zuckerberg account for only 10% of his holdings in Facebook (FB) and only 2.5% of the voting power, so the impact to his control will be minimal.

Analysts have also questioned why Facebook would finance its capital needs via equity instead of debt. While it is true that debt is cheaper than equity, especially in a low interest rate environment, debt also comes at a cost, which can sometimes outstrip that of equity. While Facebook is currently cash rich with $3.1 billion of cash and equivalents sitting on its balance sheet vs. only $575 million of debt (not to mention $1.6 billion of operating income through the third quarter of 2013), debt can quickly become a burden on the company during leaner times. More importantly, even though banks might happily lend the company money, they will impose restrictions on future strategic moves and experimental projects that Facebook may consider crucial to its growth. Such restrictions are particularly onerous for technology companies that need to innovate quickly to meet the changing demands of consumers.

MORE: Bill Gates 2.0? Keep dreaming, Mr. Zuckerberg

Finally, the fundamentals. What bearish investors are missing about Facebook is that the power of the company's social media platform does not lie in its immediate profit potential but in its formidable reach and addictive nature. With 1.19 billion users, Facebook reaches 17% of the entire world's population, a fact that positions the company as probably the most powerful medium of the new millennium, and while its popularity with teens may have declined somewhat, it remains and will remain in the foreseeable future, the Match.com of social media.

Its ad-delivery engine is excellent, and the company has managed to crack the $9.6 billion mobile advertising market (the company makes half its revenues through ads to the 500 million people who check Facebook on their phones every day). While Facebook has faced intense criticism because of its track record on privacy, the reality is that what the data mining the company has been doing (officially or unofficially) is enabling it to enhance its user experience constantly. What all this means is that the stock contains a lot of potential that remains to be tapped, and should remain attractive to value investors.

Investors are welcome to question the company's motives for selling new shares (my best guess is that Zuckerberg wants to pump more money into exploring new technologies à la Google (GOOG) and into enhancing the mobile experience to increase its ad revenues from that side) as well as its valuation, but they should also remember that Facebook stock fell nearly 50% after its botched IPO and has had to rise from (arguably) an artificially low baseline – making the likelihood of overvaluation even more remote.

So for investors who are willing to weather temporary doubts and hold a great asset, there will be plenty to "Like" about the stock in 2014.

Sanjay Sanghoee is a political and business commentator. He has worked at investment banks Lazard Freres and Dresdner Kleinwort Wasserstein. He does not own Facebook shares.

Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by WordPress.com VIP.