In most cases, a technology company initial public offering (IPO) is cause for celebration. The IPO is supposed to mark a new beginning, where executives finally cash in on the chips from their sleepless nights, transition into the nouveau riche class and party it up. Meanwhile, the prevailing economy is likely to be on the uptick, as IPO and merger and acquisition activity trigger a self-reinforcing loop of riches between Wall Street and Silicon Valley. With the recent May 18, 2012, Facebook (FB) IPO, however, the event represents yet another gruesome reminder of today's Dead Money Era. Looking back, we will view public Facebook as a stock that crashed and burned, before it even got off the ground.
The Initial Public Offering
At Facebook's initial public offering, the formerly private company raised cash through equity financing. In exchange for putting up cash, investors now own shares that represent ownership stakes within the business. Today, Facebook investors can trade shares between themselves on the Nasdaq stock market. According to Reuters, Facebook articulated plans to raise $12 billion with its IPO, which then valued the corporation at more than $100 billion. To facilitate this deal, Facebook has hired JPMorgan, Morgan Stanley and Goldman Sachs as lead underwriters, who set an initial price of $38 for shares.
For the Big Banks, Facebook was a "successful" IPO.
And by "successful," I am highlighting the fact that Facebook shares immediately spiked to $45 - from their $38 opening price at the opening bell. After hitting $45, shares promptly collapsed to $26 over the next week. At the top, of course, insiders sold out their positions to naive retail investors who bought into the hysteria. As the smoke clears, Facebook executives will have already closed on fancy homes and financed tricked out exotic cars to cruise El Camino Real, while fat cat Wall Street suits effectively blow rings of cigar smoke in our faces on CNBC and guffaw over the merits of weak lawsuits.
We have already seen this move before.
Prepare for Recession
This IPO was little cause for celebration, as it may best be described as a complete debacle. The Facebook IPO was a case of an offering that was under-priced and oversubscribed, in terms of road show hype that precipitated artificial investor demand. The instantaneous, vertical surge in shares signaled a lose-lose situation, where Facebook left money on the table to finance its operations, and its new shareholder base of mom-and-pop savers who bought into the business at the top now clutch to a bag of toxic assets.
Real, long-term investors got blown out, before the game even started.
In these previous articles, Facebook IPO: Thanks but No Thanks and Zuckerberg Shoots Self in Foot, I forecast that this social media outfit mistimed its IPO. Facebook could have especially gone for the jugular, had it of debuted during 2011 or even Q1 2012. Over the course of the past year, we have been (mis)treated to a Web 2.0 parade featuring the likes of Pandora (P), Groupon (GRPN) and Yelp (YELP), which all went public amid great fanfare and cheap money, only to promptly collapse. Groupon stock touched the sky at $31 on its opening week of trading in November 2011, before grinding down a cliff in a slow motion train wreck toward today's $9. Investors have drawn a line in the sand, and will quickly castigate corporations that cannot turn significant profits.
Unfortunately for Facebook, the U.S. economy is showing cracks within its foundation, while the European continent teeters upon the brink of complete financial collapse. Despite our unprecedented campaign to keep interest rates at effectively zero on both sides of the Atlantic, jobs creation has been nonexistent, austerity is a political rallying cry, and mass anarchy has come to be expected. Central Bank monetary policy is a blunt tool that is unable to direct capital into specific channels. Inflation is the order of the day, as we grapple against $1,500 gold, $100 crude, and $40,000 tuition bills, without any near term catalysts for wage growth.
Traders obviously recognize the writing on the wall - with The Dow Jones Industrial Average stalling out at 13,000 and quickly breaking down to 12,100 through the month of May and into early June. With recession imminent, corporate earnings and price multiples on stocks will deteriorate.
The Bottom Line
Facebook's S-1 registration statement with the SEC reports 2011 net income of $1 billion. After Facebook's initial implosion, the market still values this corporation at $76 billion, and trades its shares for 59 times earnings. Super investor Peter Lynch reasons that fairly valued stocks carry price to earnings/growth ratios of less than one. According to this metric, Facebook would need to double its year-over-year profits over the course of the next five years to justify its current valuation.
According to limited S-1 data, the company first turned a profit of $229 million in 2009. From there, earnings grew to $606 million and $1 billion over the next two years. In Q1 2012, Facebook earnings of $205 million are actually down from the 2011 $233 million year-over-year mark. For Menlo Park executives and prospective investors, earnings growth is clearly decelerating at the worst possible time.
The nominal data may remain impressive, but a growth story trading between 50 and 100 times earnings since going public leaves no margin for error. The very same sheep that buy into this thing at the top will represent the very same bear pack herd that stampedes out after Facebook's first earnings miss.
I am not convinced that Facebook will be able to convert its standing army of 901 million monthly users into serious cash. Within its sixth S-1 amendment, Facebook has already indicated that its site generates less advertising revenue, as users log on over smart phone mobile devices. Facebook can only jam so many ads into our faces - within a 3 by 2 inch screen.
Unfortunately, the Facebook IPO and its disastrous returns are yet another sign of the times. Today, our marketplace and political landscape are littered with business plans, bailouts, social programs and campaign rhetoric that sound good in principle, but fail to deliver results in reality.
For America, the beat goes on.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
