Thursday, May 31, 2012

Facebook Stock: What's Going Wrong?

Just a month ago, among the investing public, nothing was more hip or more fashionable than the planned Facebook stock offering.  This would be the most prominent, most anticipated IPO since Google. Investors from coast to coast--from institutions to moms and pops, uncles and aunts--maneuvered and schmoozed to get a piece of the action. The pre-IPO "road show" was circus-like with the business media clinging to every move of the Facebook management team, especially when the team paraded into New York.  Underwriters spent weeks jockeying for position, while some investors whined when they weren't promised a gold-mine allotment of shares.

A month later, Facebook shares have stumbled out of the gates and fallen flat, and now analysts, market watchers and pundits everywhere are trying to figure out what went wrong. Some blame the lead underwriters (Morgan Stanley, Goldman Sachs and JPMorgan) for mis-pricing the offering, for  over-valuing the company, and for bad timing. Some blame the Nasdaq exchange--at least for the first-day technical blunders. Some blame the worries and threats from Europe.  Some blame recurring fears from retail investors, who shudder and flee equity markets when the going gets rough.

Whatever, share prices that opened at $38/share are now down over 20% in the first two weeks, don't seem to have stabilized, and just haven't found a comfortable first-month trading range. When the IPO was on the drawing board this winter, bankers and traders simply assumed the stock would be comfortably trading in the high 40s now.

What went wrong?  Or what are investors responding to?

1.  IPO Pricing Often underwriters of IPOs are accused of under-pricing shares. Such under-pricing permits a first-day surge and first-day euphoria around the new stock.  Sometimes underwriters are accused of not issuing the stock at the highest price possible to permit the company to generate the highest proceeds possible from the offering.  Aware of this, Morgan Stanley and team may have been extra careful to price the stock to make it attractive to the public, yet maximize the proceeds to the company.

(If the underwriting had been priced (more fairly?) at current prices, the company would have raised about $2-3 billion less in funds.)

2.  Supply vs. Demand.  For much of the past year, the Facebook IPO has been a looming, dominant, and popular discussion topic in investment banking and equity markets. Underwriters, who normally rely on exquisite, near-scientific market intelligence to price shares or measure precisely the market demand for them, may have over-estimated demand after the first day. They may have been influenced more by the "talk" and glow of the underwriting on the first day, less by the actual, expected demand on the second day.

3.  Uncertain Revenue Streams.  With the shares out the door and into the hands of the investing public (including hedge funds, mutual funds, pension funds, and others),  analysts and traders may have realized something they suspected all along.  The company's future revenue streams are more uncertain or undefined than we thought several months ago.  What happens when the number of  users of the social network reaches an inevitable plateau? How will the company reach certain levels of revenue? How will it sustain revenues at that level? And just as important, how will it grow them? What strategies (acquisitions?) will help propel growth? All factors that have impact on the long-term valuation of the company.

Investors, researchers, market-makers and analysts--this week--are asking these questions more emphatically than they did a few weeks ago, when they may have been blinded by the euphoria of the offering, hoping, despite any concerns, to take advantage of the first-day or first-week surge in price.

Some are presenting the same questions to the company and underwriters, questioning whether they explained these uncertainties carefully in regulatory prospectuses or questioning how they could be so imprecise in valuing the company. 

4. Fear of the Fad.  Perhaps some investors, traders and research analysts have fear of the fad. They reason Facebook will remain fashionable until one day it isn't, the day when the next new thing supplants it. The hundreds of millions of account-users are not eternally wedded to it; they aren't locked into long-term contracts, nor is there a substantial cost in fleeing to the next new thing.  This group of investors could be frightened by the immeasurable whims of millions of individual users.

5.  Absence of Bottom-Fishers.  With over 900 million users, an elephantine data base, and a reliable stream of core advertising revenues, the company has a minimum value of some kind, likely still in the billions. That would make it attractive to the market's bottom-fishers, investors who wait for share prices to slide to a perceived bottom and then grab them at a bargain.  With Facebook, the bottom-fishers may be sitting on the sidelines momentarily. They have not emerged en masse, watching the momentum of the slide continue. At some point, the slide ebbs, and they scoop up the bargains.

But where will the slide end? At $20/share? At $15?

Expect the rocky, volatile start to Facebook as a public company to continue, at least until the day in mid-July when Zuckerberg and team have their first earnings conference call with the piranhas from investment firms, research firms, and hedge funds raising their hands to ask what happened and why. That performance could be the pivotal point in the stock's first-year performance.

Tracy Williams

See also  

CFN:  Facebook and Its Underwriters, 2012

CFN: Goldman Sachs and Its Private Equity Investment in Facebook, 2011

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