Warren Buffett’s recent annual letter to shareholders created an uproar in the Wall Street. He revealed the trick conglomerate or, as you may call them, holding companies use to make money. He called this trick “investing illusion.” These companies are in the business of acquiring unrelated businesses. I worry about Facedrive (TSXV:FD) stock’s unprecedented valuation. Is this valuation an investing illusion or signs of the next Tesla?
Buffett raised a good point in his letter. A great company will not sell its business, but a mediocre company that lacks competitiveness will. The conglomerates who are in the acquisition business are stuck in the universe of mediocre companies for which they pay a hefty premium.
To fund these costly acquisitions, these conglomerates promote their business, create media hype, use “imaginative” accounting maneuvers to overvalue their stocks. If they succeed in overvaluing their stocks, they use their shares as a currency to acquire those mediocre companies.
In the words of Buffett, “Investing illusions can continue for a surprisingly long time. Wall Street loves the fees that deal-making generates, and the press loves the stories that colorful promoters provide. At a point, the soaring price of a promoted stock can itself become the ‘proof’ that an illusion is a reality. Eventually, of course, the party ends, and many business ’emperors’ are found to have no clothes.”
Facedrive stock created a lot of hype in less than two years since it started trading in September 2019. The stock has grown from $2.05 to $41.87 — up almost 2,000%. Now, there were two instances of buying momentum that caused this 2,000% growth. The first momentum came between April and July.
Facedrive increased its stock price by 500% by acquiring a bankrupt company. How did it do that? Facedrive is running a “people-and-planet-first” promotion to attract ESG (environmental, social, governance) investing. It spent $9.3 million on sales and marketing to generate less than $750,000 in revenue in the first nine months of 2020. The company is spending $12 on promotion to generate $1 in revenue.
In September 2020, Facedrive acquired electric vehicle (EV) subscription service Steer for US$3.25 million. This acquisition was purely an exchange of shares. Facedrive gave Steer 222,819 FD shares for $19.2737 each, with an 18-month lock-in. Buffett describes such acquisitions as, “I’ll pay you $10,000 for your dog by giving you two of my $5,000 cats.” Facedrive stock’s second momentum came in January and February when it announced the launch of Steer services in Canada.
If you look at the background of Facedrive CEO Sayan Navaratnam, he is senior managing director at Valens Capital Management. He is also a chairman and CEO of a handful of companies like Creative Vistas, AC Technical Systems, and Connex Telecommunications. These companies have more subsidiaries.
For less than $1 million in revenue, Facedrive is operating six businesses; Facedrive Rideshare, Facedrive Marketplace, Facedrive Foods, Facedrive Social, Facedrive Health, and Steer. All verticals are different from the other. That makes me wonder what business is Facedrive into: tech platforms or holding companies. Many analysts are calling Facedrive the next Tesla, probably because it is promoting itself as a sustainable ride-sharing business.
But I will suggest you stay away from Facedrive, as its valuation of 4,000 times its sales per share is crazy, even for a growth stock. I wouldn’t be surprised if its business “emperors” are found to have no clothes after the investing illusion fades and reality strikes.
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Fool contributor Puja Tayal has no position in any of the stocks mentioned. David Gardner owns shares of Tesla. Tom Gardner owns shares of Tesla. The Motley Fool owns shares of and recommends Tesla.
The post Warren Buffett: Is Facedrive (TSXV:FD) an Investing Illusion or the Next Tesla? appeared first on The Motley Fool Canada.
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