Facebook: Now Things Get Real

Aug. 7.12 | About: Facebook (FB)

I decided not to write about Facebook's (FB) first quarterly earnings report as a publicly traded company, because there were enough people that did. Facebook beat in terms of revenues, but earnings per share just matched analyst forecasts. Now that everyone has had a chance to break down the results, I'm going to analyze where things stand and where things are going. I said in late June that the real fun was about to start with Facebook. That process has started.

Analyst Views and Expectations:

Before Facebook released its earnings report, analysts were looking for 2012 revenues of $4.91 billion, or 32.2% growth. They were expecting $0.51 per share in earnings, compared to $0.43 in the prior year.

For 2013, analysts were expecting $6.48 billion in revenues, or 32% growth. Earnings per share were expected to come in at $0.65.

Since that point, analysts have increased their 2012 revenue forecast average to $4.93 billion, or 32.9% growth. However, they have taken down their earnings per share forecast by two cents, to $0.49.

For 2013, the revenue forecast has been cut to $6.37 billion, or 29.1% growth. That's a bit of a take down. Earnings per share estimates have come down by a penny overall to $0.64.

So overall, three of the four estimates have come down, and the one that was increased (this year's revenues), takes into account that the company beat expectations by about $30 million in the Q2 earnings report. However, the overall forecast has been raised by about $20 million, so overall, you could make the case that the 2012 revenue number has been cut as well.

When I reported on Facebook in June, this is how analysts overall saw the name, and remember, this was before any of the underwriters could publish reports on the name.

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.

Currently, there are 36 analysts with a rating on the name. 6 have strong buys, 11 have buys, 17 have holds, 1 underperform, and 1 sell rating. The overall rating is a 2.2, implying a slightly stronger buy than my last update. However, the average price target is now $35.89, a decline of nearly $3. The range has also been lowered from $23 to $45.

When I last analyzed the company, Facebook was trading at $33. I called it a short idea then, and now it is at $21.

Insider Lock Ups:

Some traders are starting to position themselves for the lock up expiration periods, and are taking the bearish side of that trade. Facebook opted for a tiered lock-up release system, meaning that shares would become available as following:

The first batch of 271 million locked-up Facebook shares will become available for trading in just two weeks, on Aug. 16, with another 249 million shares free to hit the market starting Oct. 15, an additional 1.32 billion Nov. 14 and 149 million more Dec. 14. The final 47 million shares will be available for trading next May.

That 249 million shares doesn't seem like much compared to the November 14th number, but it still is quite a bit. Facebook has averaged about 48.5 million shares traded per day, meaning that about five full trading days of volume will be available for sale starting on August 16th. But if you take out Facebook's first five trading days and the day before and day after earnings, the average volume is just 31 million shares. There are also plenty of days where volume has been under 20 million, so you are potentially talking about up to two full weeks of volume, in terms of shares that can be sold. That could provide a lot of pressure for shares.

The theory behind the lockups has been to be bearish going in. Groupon (GRPN) saw its shares sink nearly 9% when its lockup date hit, and Zynga (ZNGA) dropped 8% when its first lock up date hit. Zynga had a similar lockup structure to that of Facebook. We also saw LinkedIn (LNKD) shares weak going into the lockups, but they have rallied strongly since. More on that later.

A Continuation of a downward trend:

It has not been a great start for social media and other related names, unless you are LinkedIn. LinkedIn proved again Friday why it is the best name in this space to own, rallying 16% after another impressive quarterly earnings report. If shares rise another 10%, we're going to start talking about LinkedIn shares hitting new all-time highs.

If Facebook rose 10% from here, it would be at $23.20, hardly impressive, and down nearly 50% from where it was early on the first day. In fact, Facebook shares were under $20 for part of Friday, only rallying thanks to a huge market rally and the jump in shares of LinkedIn, which helped this sector rally.

But other than LinkedIn, Facebook has followed in the footsteps of many names in this space, including Pandora (P). The following table shows where they stand in relation to their IPO prices.

Stock IPO Date IPO Price Current Change
LNKD 5/9/11 $45.00 $108.51 141.13%
GRPN 11/4/11 $20.00 $6.59 -67.05%
P 6/15/11 $16.00 $9.55 -40.31%
ZNGA 5/16/2011 $10.00 $2.72 -72.80%
FB 5/18/12 $38.00 $21.09 -44.50%
Click to enlarge

Facebook is down nearly 45% from its IPO price, one reason why insiders may dump their shares as soon as possible to cut their losses. Facebook has a long way to go still to match the 70% average declines in Groupon or Zynga, but some think it's possible. The article I provided above on the lockups shows an example of one trader's call for this name to go to $15.

Conclusion - We go lower:

We are less than two weeks away from that first lock up expiration. The earnings report was terrible, in terms of stock performance afterwards. Facebook shares rallied on Friday thanks to LinkedIn and the overall market, but if the market comes back down over the next couple of days, Facebook will probably lose $20.

When it comes to valuation, it just is too high right now. Even if we give Facebook a 35 P/E based on 2013 earnings, that gives a price target of $22.40, not too much above where this stock trades now. Give it a more realistic P/E of 30, which I think it will trade to over time, and you're talking about a $19 target for next year. Thus, investors should continue to short this name if it goes any higher.

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