Photo: Paws on Parole
Before I get to the fast-growing fraud — defined as a user who is not what the user pretends to be, which may or may not have legal ramifications — let me recap some things about Facebook.A tech blogger wrote to me: “I didn’t realise that FB’s last quarter was a net loss on a GAAP basis. I should be paying more attention I guess.” Facebook clearly disclosed the loss. But many financial “reporters” omitted the loss from recent articles that hyped the stock.
For the third quarter of 2012, on a GAAP basis (the accounting standard for U.S. corporations), Facebook lost 2 cents a share versus making 10 cents a share the prior year. It lost money in the second quarter, too. In other words, Facebook lost money every quarter since its IPO on a GAAP accounting basis. Its margins were squeezed as decelerating revenues didn’t keep up with growing costs — “user growth” isn’t always a good thing — and it lost important gaming revenues.
It also annoyed users, alienated advertisers, and had an exodus of top talent. Facebook’s initial public offering (IPO) came to market at a price of $38 on May 17, 2012, and it rose as high as $45. It closed on November 23 at $24; a 37 per cent decline from its IPO price and down 47 per cent from its high.
Many financial reporters didn’t mention Facebook lost money last quarter, and as far as I know, none of them reported the enormous percentage increase in fraud. Perhaps that’s because you have to crunch some numbers to see it.
In its S-1 filed May 16, 2012, Facebook reported it had 483 million daily active users (DAUs) and 845 million monthly average users (MAUs) as of December 31, 2011. It said it made “reasonable estimates” that 5-6 per cent of the MAUs were fakes and repeated this in its Prospectus filed May 18, 2012. But in its 10-Q filing for the period ending June 30, 2012, Facebook reported 552 million DAUs and 955 million MAUs, and fakes were estimated at 8.7 per cent of MAUs. The reported percentage of fakes had climbed, and the percentage was reported on a higher “user” base.
Now here’s the tricky part. One would hope that Facebook netted out its estimated fakes when it reported its MAUs. If so, that wasn’t clear to reporters, and it isn’t specifically stated (that I could find) in the S-1, Prospectus, or the 10-K for the period ending June 30, 2012. If you don’t net out the estimated fakes before reporting, then 8.7 per cent of 955 million, or 83 million are estimated fakes as of June 30, and that number was widely reported.
If you assume Facebook netted out the fakes before reporting numbers, then the fakes are 91 million for June 30. Why is that important? It determines the base upon which growth is calculated. If Facebook doesn’t net out the fakes, it makes MAU growth look higher (because if Facebook didn’t underreport at its IPO, then fakes are growing much faster) and it makes the growth of fakes look lower.
For purposes of showing the fast rate of fake growth, I’ll show numbers assuming first that Facebook didn’t net out fakes — as many financial reporters assumed — and I’ll show growth rates in parentheses as if Facebook did net out the fakes. The MAU growths shown in the next paragraph are calculated based on Facebook’s reported MAUs:
During the six month period from December 31, 2011, to June 30, 2012, daily average users (DAUs) grew 14.3 per cent or around 30.6 per cent annualized. Monthly average users (MAUs) grew 13 per cent or around 28 per cent annualized. Relative to the December 31, 2011 base of 845 million with 5-6 per cent fake users, Facebook reported a 64-97 per cent increase in fake users (69-104 per cent increase in fakes if Facebook netted before reporting the 845 million MAUs), or an increase of around 168-287 per cent in fake users on an annualized basis (185-319 per cent increase in fake users on an annualized basis if Facebook netted before reporting the 845 million MAUs).
No matter how you look at it, at the time of its IPO, Facebook either underreported the fraud problem, or the fraud growth soared. When was Facebook first invaded by this “new” herd of the walking dead? If Facebook didn’t underreport, then why is fraud soaring?
Laughable Disclosure Claim: “Meaningfully Lower” Fake Profile Percentage in Developed World
Facebook’s 10-Q for the period ending 9/30/12 claimed: “We believe that the percentage of accounts that are duplicate or false is meaningfully lower in developed markets such as the United States or Australia and higher in developing markets such as Indonesia and Turkey.” Facebook goes on to explain why its claim isn’t trustworthy. It’s great comedy.
Based on my unscientific poll of 50 Facebook U.S.-based users (I’m not a user), many have multiple accounts. Reasons given included 1) one account for gaming and another for job applications, 2) a false persona account to be friended by an old girlfriend to spy on her (I gave that guy a wide berth), and 3) fantasy persona accounts to interact as a kind of “second life.” Even when a user profile was “genuine,” many users gave alternate email addresses and fake phone numbers, because they don’t trust Facebook to protect their privacy. Facebook itself lists more reasons, including — but not limited to — profiles of pets and spammers. (See Appendix III.)
In its disclosures, Facebook never specifically mentions the word “impersonator” i.e., identity thief. I found that personally interesting, because as I wrote in July 2011, someone put up a fake profile of me. Thanks to Google Alerts, I discovered the problem. In order to get it removed, I had to prove my identity to Facebook with a government issued I.D., yet the identity thief didn’t have to prove anything at all to create the fake. I didn’t want to fork over personal information to Facebook, but the alternative was that a fraudster might use the fake profile maliciously.
Facebook reminded me of a punk holding a screw driver over your parked car’s paint job demanding payment to “protect” it as you run errands. To be clear, I’m not accusing Facebook of creating the fraudulent profile. Anyone — including Facebook — could have done it, but Facebook made it easy for fraudsters. (See Appendix IV.)
Facebook doesn’t know how many profiles are impersonators, imposters or other types of frauds. Yet to prove identity to purge an identity theft, Facebook demands a government issued I.D. So why shouldn’t you demand the same proof before accepting any of Facebook’s user profiles as genuine? Using its own standards, the quality of Facebook’s user data stinks.
Disclosure: I’ve bought and monetized puts on Facebook since they became exchange-traded shortly after the IPO. (“Investors Bet on Facebook Fall,” Kaitlyn Kiernan and Jonathan Cheng, Wall Street Journal, May 19, 2012.) I’m currently long other puts on Facebook.
This post is excerpted from a longer report: “Facebook: Soaring Fraud and Decelerating User Growth,” TSF, November 26, 2012.
Also by Janet Tavakoli on Facebook’s problems:
“Facebook’s Mobile Revenues Strategy and “Promote Posts” in Trouble” – November 16, 2012
“Facebook’s Stock: New Strong Sell Signals” – October 31, 2012
“Facebook’s Plummeting Stock Price” — October 16, 2012
“Facebook: Is Stock Research Rigged?” — July 26, 2012
“The Biggest Headache for Investors in Groupon and Facebook” — March 2, 2011
Read more posts on Tavakoli Structured Finance »
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