Quite often, a buy/sell call that merely follows consensus will just result in a stock moving in the opposite direction of that call. In the past, Zynga (ZNGA) was considered a possible buy at $6. Zynga shares only stopped declining temporarily in June. After Zynga reported second quarter earnings, shares sold-off sharply, and recently traded at $3.06.
Zynga said that changes on Facebook (FB) made its games harder to find, which hurt revenue. Zynga also forecast earnings for 2012 to be in the range of $0.04 - $0.09 per share, compared with a prior range of between $0.23 - $0.29 per share.
Facebook, rated as a company to avoid on May 31, traded recently at $22.18. If shares drift below $20 again, traders will start guessing what the bottom price will be.
Bearish option trading and a rise in short selling imply that the consensus believes that Facebook is a "sell." There are still a number of reasons that support this bearish sentiment.
Reason #1: Forecasted earnings may be too high.
The problem with assigning a value on Facebook based on a forward P/E is that the earnings estimate could be too high. The EPS forecast was set shortly before Facebook went public. The table below illustrates the range of forward P/E values for the stock price, using 2013 estimates:
Forward P/E with 2013 EPS Estimate: $0.63
Forward P/E with 2013 EPS Estimate: $0.83
Average Forward P/E
Reason #2: The lockup period ends will hurt Facebook shares.
After the lockup period ended for Groupon (GRPN) and Zynga , share dilution hurt the value of shares for the two companies. Groupon and Zynga are now 77.6% and 80.7% below their 52-week high, respectively.
With 1.879 billion shares currently outstanding, Facebook’s lock-up period will further dilute shares. By May 2013, Facebook will have 2.74 billion shares outstanding. Most shares will be released on November 14:
Date Expiry Ends
# Shares Added
Current Shares Outstanding:
Reason #3: Costs are rising faster than revenue growth.
Growing companies justify growing costs as necessary for growth. Facebook reported costs far higher than revenue growth achieved in the year-to-date.
Facebook explained that share-based compensation contributed to the bulk of the total costs and expenses. In its filing, Facebook reported a 38% rise in revenue for the six months ending June 30, 2012. Cost of revenue increased 71% to $644 million, Research and development increased 450% to $858 million, marketing and sales increased 239% to $535 million, and general and administrative increased 305% to $567 million. In aggregate, share-based compensation accounted for 42.5% of the expenses. The $1.2 billion in share-based compensation was a 17-fold increase over 2011.
Reason #4: Goodwill assets increased to $684 million, up from $51 million in December 31, 2011.
The price action of AOL and Microsoft suggests that the market is favoring companies monetizing their patents. AOL shares are $32.63, a 52-week high. In its earnings call, AOL plans to generate $1.1 billion from the sale of patents. AOL will then be returning that amount to shareholders. In contrast, Research in Motion (RIMM) acquired expensive patents last year, but the acquisition failed to provide support for shares. Eastman Kodak hoped to monetize its patents, but received opening bids of just $150 - $250 million.
Reason #5: Facebook relies on over 10% of its revenue on one client
Facebook decreased its reliance on Zynga from 12% in 2011 to 10%, but should expect to see a further decline in revenue from Zynga as this client struggles. Facebook began displaying sponsored ads on Zynga.com, but Zynga will need to grow for Facebook to benefit.
Reason #6: MAU, or Monthly Active Users, is a flawed metric.
Facebook focuses heavily on MAU to measure user-growth, but the metric does not necessarily correlate to earnings or revenue growth. Growing the user base also adds proportionately to costs. The company said it had 955 million MAU's. The figure includes a "user who logged in and visited Facebook through our website or a mobile device, or took an action to share content or activity with his or her Facebook friends or connections via a third-party website that is integrated with Facebook, in the last 30 days as of the date of measurement."
Reason #7: Facebook has a liquidation value of between $3.72 and $5.15 per share.
Facebook will not trade at liquidation value, so long as its growth justifies its stock price multiples. Excluding goodwill, Facebook has $14.119 billion, or $5.15 per share in assets.
Facebook generated $6.3 billion of its cash balance from the net proceeds of its IPO. The company currently has cash and cash equivalents totaling $10.2 billion ($3.72 per share).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.