One of the biggest IPOs ever has fallen flat. Facebook (FB) shares tanked more than 10% on Monday as investors are seeing through the hype. Leading up to this offering, I had extremely passive investors asking me if they should invest in Facebook, and my answer to all of them was the same, no. You can read all about potential revenue and earnings growth, but how many people actually click on the ads on the side of Facebook? The average click-through rate (CTR) of an ad on the Google Display Network is 0.4% - almost 10 times as high as the typical Facebook ad. Average CTR on Facebook is under 0.05%, about half the industry average for online banner ads. At the same time, costs per thousand impressions on Facebook are climbing.
The Facebook CTR is actually falling as it was 0.063% in 2009, showing that while common market thought is that the company will improve in targeting ads, empirical evidence shows that the company is actually becoming less effective.
The stock started trading with a PE above 80, compared with a 13.5 for Apple (AAPL) and 18.6 for Google (GOOG); the Nasdaq index of tech stocks trades at 20.8 times its trailing twelve-month earnings. There is definitely room for revenue and earnings growth as the website tries to become a moneymaking machine; however, even with a PE ratio of 50, the stock is worth $21.50. Right now, the underwriters are keeping it up, even with the more than 10% drop during trading on Monday. Let's remember, FB is only a website, but it has become a verb as well, similar to Google. Google is much more than just a website these days, but it got its beginnings as a search engine. People don't say that they are going to research something on the internet anymore, they google it. It has become a networking tool, and a way for employers to get a sense of potential future employees. Privacy concerns abound, but Facebook's situation is not unlike many other tech companies that are seeing some backlash (think Google and its tracking software) for new products. It is also one of the few profitable websites around and has more than 900 million users.
Other tech IPOs such as LinkedIn (LNKD), Groupon (GRPN), and Zynga (ZNGA) were three that have fallen short of expectations. LNKD IPO'd almost a year ago now and is up 4%, while GRPN IPO'd back in November of 2011 (down 52%) and ZNGA IPO'd back in December of 2011, and is down 25%. What is going to set Facebook apart from the rest of these disappointments? The obvious answer is the 902 million users, but the majority of those users have never paid for anything on Facebook, and according to the data I previously mentioned, very few of them are actually clicking on the advertisements. Facebook has marketed itself as a free option and many of its applications that work with the social networking website have no cost to the consumer.
During the three months ended March 31, 2012, FB earned $0.09 per share on $1.06 billion of revenue. The stock IPO'd at $38 and traded as high as $42.00, but even help from the underwriters could not keep the stock up on Monday. On Friday, lead underwriter Morgan Stanley (MS) held 162 million shares, worth $6.16 billion, while other banks including JP Morgan (JPM) and Goldman Sachs (GS) also bought shares, ending Friday with $3.2 billion and $2.4 billion holdings respectively.
The Nasdaq (QQQ) had a strong day, gaining 2.5% during trading, but still FB saw the weakness. The IPO raised $16 billion, and valued FB at $104 billion; however, just before the offering, Facebook expanded the number of shares by 25%, to 421.2 million. It appears that Morgan Stanley over expanded the IPO and now demand is clearly being outstripped by supply. The Street had modeled for earnings of $0.60 per share for 2013; trading at the average for the Nasdaq tech sector yields a price of approximately $12.50.
As I have told many private investors over the past few weeks, I would avoid shares of Facebook.