Stock Watch


Investors Unlike Facebook's IPO

Kathy Kristof

Clarity about the social network's earnings potential would help make this stock more likeable. Until then, watch and wait.



Consumers may hit Facebook’s “Like” button billions of times each day, but investors in the Menlo Park-based social-networking site don’t like what’s happened to the value of their shares since Facebook (symbol FB) went public on May 18.

SEE ALSO: 4 Lessons for Investing in IPOs

After coming out at $38 in a much ballyhooed debut, Facebook shares have been sliding steadily, closing at $29.60 on May 31 -- down 22% from the IPO price and 34% below the stock’s first-day high of $45.00. A slew of investors are suing, claiming that the company’s officers and directors only selectively disclosed diminished revenue estimates, which may have helped tank the stock. Experts almost universally agree that this launch, expected to be the best and brightest new issue in years, has turned into the market’s biggest disaster. (Kiplinger’s took a cautious stance on Facebook before the IPO.)

Of course, it’s not unusual for the shares of an IPO to fall in the weeks after the launch. That’s because both management and the company’s underwriters -- a whopping 33 different investment banks, in this case -- are required by law to go into a quiet period and are unable to defend the stock for 40 days. That gives naysayers time to weigh in, while few supporters can speak up. Some experts contend that quiet periods frequently prove to be a great time to buy, particularly when a profitable company’s stock falls below the IPO price, as it has with Facebook. “The guys who underwrote the deal are going to come out with some research on June 26, and I think people will start to believe then,” says Michael Pachter, managing director of research at Wedbush Securities. Pachter is a fan of the stock and predicts that it will sell for $44 within a year.

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But other experts believe that Facebook simply came out at too high a price and presents such significant risks to investors that it may not make sense to buy until some of the questions are answered. “We are fully aware of all that the company has achieved. But when we were looking through the regulatory filings, we were struck by the volume and significance of the investment risks,” says Scott Kessler, a technology analyst with S&P Capital IQ. Kessler, who recommends selling the stock, has a 12-month price target of $27.

What makes Facebook’s value such a thorny question is that the company appears to be at a crossroads. Facebook’s first-quarter financial results showed that the growth that had allowed the company to quadruple in size and profitability over the past three years came to a grinding halt. During the three months that ended March 31, Facebook revenues rose 45% from the same period in 2011, but profits were down 12%.

Moreover, although first-quarter revenues were up from year-ago levels, they were down from the October-December period -- Facebook’s first quarterly revenue decline since 2010. And it was the first year-over-year decline in profits in the company’s reporting history.

The culprits were higher expenses and lower advertising revenues, and both appear likely to persist. Facebook said in a May 16 securities filing that it will continue to invest heavily in infrastructure. Meanwhile, General Motors has pulled $10 million in ads from the site, saying that they were not effective -- an ominous sign, given that paid advertising accounts for 82% of Facebook’s revenue. If Facebook’s rapid growth is slowing, there’s little chance the stock could support even today’s diminished price, which equates to 67 times the past 12 months’ earnings. If the company were to grow at a more tepid pace, a share price between $9 and $13 -- 20 to 30 times current 12-month earnings -- could be reasonable.

Bulls counter that Facebook has some 900 million active monthly users begging to be “monetized” -- in other words, used to make a profit for the site. Although Facebook’s revenue has primarily come from traditional advertising in the past, the company is working on ways to sell advertisements to people who access the site through smart phones. It has also launched an app store, and it collects commissions when someone converts real money into the cyber-cash required to play online games. “I happen to believe the company is going to push the needle off the scale based on how it grows revenue from existing customers,” says David Menlow, president of IPO Financial Network, a research company that focuses on newly public stocks.

However, Menlow adds, valuing the stock in today’s environment is nearly impossible. Even though the company’s potential is great, the sources of Facebook’s future revenue have not yet been established.

The best advice for individuals, says Menlow, is to step away until the stock has settled and institutional investors appear willing to commit their money. “So far, institutions have treated Facebook as if it were carcinogenic,” he says. “There is no reason for individual investors to be involved in this stock until some sensibility has come back to the marketplace and institutions start to buy.”

What might make institutions willing to start buying? More clarity about the direction of Facebook’s earnings. That would give analysts the ability to figure out the right price to pay for the stock. Now, earnings estimates vary so widely that they’re virtually worthless, ranging from 39 cents to $1.00 per share. And without direction from the underwriters, who presumably know Facebook best -- or further earnings reports that provide a better view of the company’s direction -- there’s little reason to rush in to buy the stock.

That isn’t to say speculators won’t push the share price up at some point, likely before second-quarter earnings are announced (around August 15). But the share price could easily tumble back down if earnings continue falling or remain flat. For now, the risks in this stock are great, and the rewards are uncertain. Individual investors may want to simply watch and wait.

Kathy Kristof is a contributing editor to Kiplinger’s Personal Finance and author of the book Investing 101. Follow her on Twitter. Or email her at practicalinvesting@kiplinger.com.


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