Facebook: The Real Fun Is About To Start

Jun.25.12 | About: Facebook (FB)

It has now been more than a month since Facebook (NASDAQ:FB) started trading as a public company. The hype has come and gone, but volatility in the name has remained. After shares rallied as high as $45 during the first day of trading, shares drifted lower and lower, eventually reaching a low of $25.52 on June 6th. An impressive rally has brought shares back to more than $33. You might think that things with Facebook have settled down for now, but you'd be wrong. The real fun with this name is about to start, and here's why.

Due to the quiet period rule, underwriters for the Facebook IPO are not allowed to issue formal reports on the name until 40 days after the IPO. 40 days from the IPO date is Wednesday, so figure that during this week the 40 day period will end. You can expect those lead underwriters to start issuing their reports soon, although the exact date they issue their opinions is unclear at the moment.

Why are those reports important? Well, there were a number of rumors that Morgan Stanley analysts reduced their revenue estimates on Facebook shortly before the IPO. Generally, that is not something that analysts do right before an IPO, and especially given the size and hype of the Facebook IPO, it could be a very alarming sign if true. The negative news inside of Morgan Stanley may have been part of the reason why Facebook shares did so poorly after going public. For those reasons, I assigned a fair amount of blame to the underwriters when I analyzed who was at fault for Facebook's lousy performance.

According to opinions compiled by Yahoo Finance, 13 analysts currently have a rating on Facebook. There are 3 strong buys, 4 buys, 5 holds, and 1 sell. On a 1 (strong buy) to 5 (sell) rating scale, the average rating is a 2.4. That implies a slight buy rating. Of 11 brokers with price targets on the name, the average target is $38.73, with a range of $25 to $48. I'll get into revenue and earnings estimates later. But for now, think about this. When those leading underwriters issue their initial reports, they better be positive. If not, look for Facebook shares to lose that $30 mark. There also may be potential for some investor uproar if the negative news from Morgan Stanley was true. Investors might be unhappy and feel that the IPO was sabotaged.

The second big thing is going to be Facebook's first quarterly earnings report as a public company. The second quarter is ending, and current expectations call for $1.18 billion in revenues and a $0.15 profit. We don't have an exact date on the earnings report yet, so I would figure either late July or early August. While the numbers will certainly be important, I will also be interested to see how the company presents everything and what they have to say. How detailed is the company going to be, what kind of guidance will they give, etc.

The third important time period will be a series of dates. They are the lock-up expirations. Facebook adjusted its lock-up period prior to the IPO, so additional shares will be able to be traded. Under the new terms, about 55% of the free float (or $10 billion worth of stock) will be freed up just 90 days after the IPO. Also, even more shares will be available 151 days post-IPO, so more than double the original float will be able to be traded at that point.

There are a couple of ways to think about the lock ups. After the lock up periods expire, insiders can sell shares in the company that they didn't sell in the original IPO. Another criticism of the Facebook IPO was that when they boosted the price range just before the IPO, they also increased the number of shares, allowing more insiders to get out. If a lot of insider shares are sold once the lock ups expire, it may be a sign that people don't believe in the long term prospects of Facebook.

So let's look where those Facebook prospects stand, and I'll compare them to just a few weeks ago, when I argued that Facebook's valuation was socially unacceptable. Given the recent rise in share price, you can bet that I am still a Facebook bear. I'm going to provide some tables, which show the growth and valuation prospects for Facebook to other social networking names such as LinkedIn (NYSE:LNKD), Zynga (NASDAQ:ZNGA), Groupon (NASDAQ:GRPN), and Pandora (NYSE:P). I'll also show the analyst opinions of the names both then and now. All data from here on is as of market close on Friday.

Here's how the growth estimates stood on June 6th.

2012 Revs 33.5% 74.1% 25.4% 47.7% 54.9%
2013 Revs 30.8% 48.8% 21.2% 29.0% 43.4%
2012 EPS 25.6% 94.3% 12.5% N/A N/A
2013 EPS 20.4% 79.4% 37.0% 288.9% N/A
Click to enlarge

*Groupon expected to swing from 72 cent loss in 2011 to 18 cent profit in 2012 and 69 cent profit in 2013. Pandora expected to lose 11 cents in fiscal 2012 (ending January 2013) after a 2 cent loss in fiscal 2011. Pandora expected to swing to 5 cent profit in 2013 fiscal year (ending January 2014).

Here is the currently expected growth for these names.

2012 Revs 33.4% 74.1% 25.1% 47.8% 54.9%
2013 Revs 30.7% 48.8% 20.8% 28.8% 43.4%
2012 EPS 27.9% 94.3% 12.5% N/A N/A
2013 EPS 21.8% 79.4% 33.3% 283.3% N/A
Click to enlarge

*See note above.

Facebook's revenue growth estimates have come down ever so slightly since June 6th, but earnings per share growth numbers have been revised upwards. Zynga's revenue numbers have also come down slightly, and Zynga's 2013 earnings estimates were cut slightly as well. Groupon saw a minor revenue estimate rise for 2012, but a slight revenue cut and earnings cut for 2013. LinkedIn and Pandora estimates have not changed in the past 3 weeks.

Now, since a lot of these names have risen quite a bit since my last update, the valuations have certainly changed. The following table shows the price to sales and price to earnings ratios for each name for 2012 and 2013 revenues and earnings. The 'T' represents then, or June 6th, while 'N' represents current values.

P/S (2012) 11.15 10.57 2.91 2.63 4.00
P/S (2013) 8.54 7.12 2.40 2.04 2.79
P/E (2012) 47.91 136.76 21.22 54.39 N/A
P/E (2013) 39.80 76.23 15.49 13.99 205.60
P/S (2012) 14.27 12.15 3.04 2.80 4.26
P/S (2013) 10.92 8.18 2.52 2.17 2.97
P/E (2012) 60.09 157.13 22.22 57.78 N/A
P/E (2013) 49.33 87.58 16.67 15.07 217.20
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Facebook's valuation has come up the most of all these names, which makes it appear even more overvalued on a price to sales valuation. It remains cheaper than LinkedIn on a P/E basis, but remember that LinkedIn is providing a lot more growth. Since I believed Facebook was overvalued back on June 6th, you can bet that I still believe that it is.

The final table I'll provide will show a comparison of the analyst ratings for each and potential upside given the corresponding average price target. Remember, a rating of 1.0 equals a strong buy and a 5.0 equals a sell rating on the name.

Analyst Views 'T' FB LNKD ZNGA GRPN P
Analyst Opinion 2.4 2.4 2.4 2.6 2.3
Average Target $38.75 $128.76 $12.83 $18.12 $13.56
Upside 49.79% 38.45% 123.91% 85.09% 31.91%
Analyst Views 'N' FB LNKD ZNGA GRPN P
Analyst Opinion 2.4 2.4 2.3 2.5 2.4
Average Target $38.73 $129.31 $12.00 $17.94 $13.56
Upside 17.19% 21.02% 100.00% 72.50% 24.86%
Click to enlarge

In terms of the ratings, Zynga and Groupon are slightly stronger buys according to analysts, while Pandora is a slightly weaker buy. In terms of potential upside, Facebook has seen the greatest decline because the stock has run so much lately. But remember, all of this above doesn't include what we are about to here from the underwriters. Once they publish their opinions, these numbers could change greatly.

As you can see, the Facebook fun is about to get even greater. In the next few days, we'll start hearing from the underwriters. Do they like the stock, or were rumors of their estimate cuts prior to the IPO true? Within the next months or so, we'll also hear Facebook report earnings for the first time as a public company. Also, the lock up periods will start to expire, meaning insiders can sell and millions of shares will be added to the float.

All of these events will make an already volatile name see more action. As you can probably guess, I am still recommending a short trade on Facebook, purely based on valuation. However, it might be worth it to see what the underwriters have to say first. If they like Facebook, shares might rise even more, and you could short it higher. If they don't like it, it will provide confirmation to the slower growth prospects, and you could probably still short it down to the recent lows near $25.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.