Why I 'Liked' Facebook

| About: Facebook (FB)

Facebook (NASDAQ:FB) had its eagerly anticipated initial public offering ("IPO") on Friday and it was one of the more exciting trading days in recent history. After an opening IPO cross in the upper $40s, the stock plummeted back to its IPO price of $38 when it is widely believed that the offering underwriters had to step in to support the price. When trading was bouncing off the $38 support level, I was glued to my monitor to see if the IPO price would break; this occurring in both the late morning and towards the close as the chart reveals.

Taking a step back, the objective of an IPO is to raise funds for the offering firm and its investors without "leaving money on the table" for selling shareholders. IPOs commonly appreciate significantly on the first day for a multitude of reasons such as a shortage of demand. The benchmark for a "successfully priced" IPO is generally accepted as a 5-15% price increase on the first day, which balances the interests of buyers and sellers. The media has unduly lambasted the IPO calling it a failure, underwhelming, and even burning. Remember that a successful IPO does not 'pop' as the underwriters strive to find a relatively accurate price.

Click to enlarge:

Source: Yahoo! Finance

I purchased Facebook at its offering on Friday and while I anticipated an approximate 10% increase in the share price, I am not surprised that the stock struggled to gain traction based upon the series of unfortunate events surrounding the IPO. Below I will dissect the five reasons why the IPO failed to deliver and explain why Facebook is still a compelling investment.

NASDAQ Technical Difficulties

I was following the IPO closely on Friday morning and I felt as if I spent the majority of the morning watching "FB 38.00 UNCH". The Nasdaq (NASDAQ:NDAQ) faced delay after delay in meeting the unprecedented trading demand (573 million shares traded, or 22% of total Nasdaq volume on the day). As you can see from the chart above, trading did not begin until after 11:30AM versus the 11:00AM anticipated launch.

Even when trading opened, reports of ignored trades, missing confirmations, and overall disorder plagued the issuance. The Securities and Exchange Commission has announced that it will be investigating the trading issues and it will be an interesting situation to monitor. Nasdaq CEO Robert Greifeld blamed "poor design" and stated that "this was not our [Nasdaq's] finest hour" on a conference call with the media. The turmoil was not isolated to Facebook as trading in Zynga (NASDAQ:ZNGA) was halted for nearly fifty minutes after triggering a circuit breaker that calls for a five minute halt. Zynga ended up down over 13% as many of the Technology 2.0 companies slumped amid Facebook's lackluster performance. I believe that the trading issues shook investor confidence and put an overall damper on the excitement of the IPO. It will take days and weeks before the market can equalize and come to a consensus regarding the true market price for Facebook.

The IPO was Too Large To 'Pop'

Facebook raised $16 billion as insiders and early investors took the opportunity to cash out. With a $100B market capitalization and such a larger offering it was unlikely that the stock would appreciate significantly on its first day. Make no mistake, this was early investors' opportunity to finally liquidate and diversify their holdings.

Investors accustomed to usual IPO scarcity likely requested more shares than they actually truly wanted, which led to a flurry of selling activity in the morning. For example, if your objective was to get 1,000 shares, you might have requested 1,500 thinking that you would not receive your full allotment. If this was your plan and you actually received 1,500 shares, you would likely sell the extra 500 to reach your ideal position size.

The lack of scarcity severely hurt the deal and put more pressure than initially anticipated on the deal. This is one of the most alarming aspects of investing as Facebook and it will only get worse in 90 days when the first lock-ups expire. The strong retail interest (estimated to be 20-25%) and insider ownership by Mark Zuckerberg & Co. should impart a long-term bias and should mitigate some concerns and support the share price to some degree.

Comparisons With Google and LinkedIn Are Unfair

Facebook's IPO is very difficult to compare with other IPOs for reasons of size and complexity. Facebook is much larger than Google (NASDAQ:GOOG) was at the time of their respective IPO's and absolutely dwarfs competitor LinkedIn (NYSE:LNKD).

On one hand, a nimble Google surged from $85 to $700 in a matter of years before the global financial crisis in 2008. On the other hand, LinkedIn rose 109% on the day of its IPO with a very similar business model. LinkedIn has been called 'Facebook for professionals' so many were eyeing a similar surge despite LinkedIn having a mere fraction of Facebook's size. When a company goes public with a $5B market cap, it is far easier to double than if it goes public with a $100B market cap. Therefore, Facebook faces impossible comparisons. If Facebook did not surge on the first day of trading it failed in comparison to LinkedIn. If Facebook does not double or triple in the upcoming years, it failed in comparison to Google. Facebook does have the opportunity to double its number of users but only time will tell how that translates into financial performance.

General Motors Throws Water on the Flames

General Motors (NYSE:GM) announced mere days before Facebook's IPO that it was no longer going to pay for advertising on Facebook in a very public blow against the budding company. GM stated that its ads "had little impact on consumers" as justification for diverting its advertising budget elsewhere. Investors need to ask 'is Facebook to blame'? Young consumers are not as enamored by driving as previous generations were and that is a reflection on GM rather than Facebook. According to research firm Gartner, "forty-six percent of drivers aged 18 to 24 said they would choose Internet access over owning a car" indicating that GM cannot rely on its conventional advertising to reach the Facebook generation. This is akin to Harley Davidson (NYSE:HOG) advertising in AARP magazine and wondering why the adverts are not effective. Nevertheless, General Motor's announcement could have spooked many investors into avoiding the deal on Friday.

On the day of Facebook's IPO, GM took an even bolder step and announced that it would no longer advertise during the Superbowl due to the rising cost. Is the NFL to blame? Clearly something is occurring inside GM's advertising department that is not representative of other large companies that rely on advertising. For instance, Ford (NYSE:F) has stated that it plans to increase its advertising on Facebook.

It's The Economy, Stupid

To borrow a line from former President Clinton, the global economy is in quite a bit of trouble. The S&P 500 declined for the third week in a row, JP Morgan (NYSE:JPM) continues to lose money on its "London Whale" trades, and both Greece and Spain are on the verge of effectively extinguishing the eurozone. Can you blame investors for not stomaching the risk associated with a new public offering with a trailing PE in excess of 100? If Facebook went public in 2006, maybe it would have doubled, but the world is a different place now. When the economy recovers, Facebook should as well. In order to restore demand for products and services, advertising will be necessary and Facebook should be one of the benefactors.

Despite The Lackluster IPO, Should You Buy?

With all of these factors in mind, I do not think that Facebook is a poor investment. When the dust settles, you have a company with surprisingly strong financial condition, addicted users, and a company with a multitude of very intelligent employees that are passionate about their company. As has been oft repeated on CNBC, all Facebook has to do is monetize mobile and the stock can appreciate 25%. If Instagram is able to help in this respect, the one billion dollar price tag will be a relative bargain. Facebook is not content banking on Instagram alone as it acquired social gifting company Karma to further bolster its competitive positioning.

While I believe that Facebook is a solid near-term investment, my money is on Apple (NASDAQ:AAPL) for the long-run. Apple is currently growing at a faster rate, has stronger barriers to entry, and trades at a bargain-basement price-to-earnings ratio. As a value investor, I will almost always pick the company with the 12 PE over the one with a 100+ PE, but I think Facebook's intangibles make it an important part of your portfolio technology mix. Consumers have an emotional attachment to Facebook much as they do with Apple that keeps them coming back every time they go on a "Facebook diet" and try and remove the social network from their lives. I will be watching Facebook closely. Not only because my own money is on the line but because this is a compelling story that will be captivating to watch for years to come.

Disclosure: I am long AAPL, FB, GOOG, JPM.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500. Become a contributor »
Tagged: , , , Internet Information Providers
Problem with this article? Please tell us. Disagree with this article? .