Facebook – Microsoft on steroids.

The consequences could be serious indeed.

• If the FTC wins its case and forces Facebook to be broken up, the consequences for Facebook will be far more serious than the hit that was taken by Microsoft when it suffered similar treatment.
• This is because the valuation of the separate pieces will be way below the $791bn valuation that Facebook enjoys today due to the impact of being an ecosystem rather than a series of individual services.
• Facebook’s services have been creeping closer and closer together over the last 5 years in the execution of its long-term strategy which I have long believed is what is designed to drive its next phase of growth.
• Facebook is on the receiving end of a lawsuit from the FTC and 46 state attorneys-general accusing it of monopolistic practices that unfairly stifled competition.
• A digital ecosystem like Google, Facebook or Tencent is made up of a suite of services that together address the opportunity created by users spending time on their smartphones and tablets.
• RFM has represented this opportunity since 2913 with its Digital Life Pie and currently, this is dominated by 4 big services: Gaming, Media Consumption, Instant Messaging and Social Networking.
• Using Google as a benchmark, the global opportunity per user per month by completely covering the entire Digital Life Pie is around $5.50 per user per month.
• The calculation of this opportunity assumes that the services are integrated and that there is cross-pollination between which allows monetisation to become much more effective.
• This is because with more services. The user’s profile is more complete increasing its value and that there are more opportunities to monetise.
• This is what Google does so well which is why it is the benchmark for ecosystem monetisation outside of China.
• Improving performance in this area is what has driven some of Facebook’s most recent growth and should continue to do so for some time into the future.
• However, if the FTC wins its case and Facebook is split up say by spinning off both Instagram and WhatsApp then the whole story falls apart.
• Because the whole is worth much more than the sum of the parts, Facebook’s long-term potential for value creation will take a large hit.
• How much of a hit is difficult to quantify but as a rough estimate, I would estimate somewhere between 40% and 50%.
• This creates a huge risk for holding the shares now which are not pricing in anything like this outcome and seem to be assuming that this will not cause any lasting long-term damage like Microsoft.
• However, what is being proposed is a much more drastic remedy than the forced unbundling of internet explorer from the Windows operating system.
• This involves striking at the heart of the company and would be the equivalent of forcing Apple to spin off iOS into a separate and independent entity.
• Hence, I see minimal upside in this company until there is better visibility on how this is going to be resolved, which would enable a better assessment of the long-term damage.
• With all the good news priced in and none of the increasing risk, I would be getting out without delay.