Appalling. That would be an understatement when describing Facebook's (FB) performance since its historic IPO in May. Certainly, this was not the goal of Facebook and its underwriters, who overhyped the IPO and mispriced the stock. Yes, Mark Zuckerberg is the ultimate entrepreneur and Facebook is a phenomenal business that has enjoyed exponential user growth over the years.
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Unfortunately, as we learned more recently with its latest quarterly report, Facebook's user growth has been declining dramatically. That's primarily because most of the U.S. population, over 75%, already has a Facebook account, which leaves little room for growth here in America. In addition, to the disappointment of investors who purchased the stock at the IPO, the stock has dropped over 50% since going public in May 2012. As expected after an IPO, some employees (especially top executives) have left the company, including Katie Mitic and Ethan Beard. In fact, Facebook's most recent 10-Q explicitly acknowledges that the loss of key personnel, such as COO Sheryl Sandberg, "could disrupt our operations and have an adverse effect on our business."
In retrospect, it all began with insanity and greed when the company was valued at over $100 billion, a higher valuation than, for example, McDonald's (MCD), a proven profitable business model that was founded in 1940. From the underwriting side, there was a lot of hype and excitement based on a business model with risky and unsustainable financial projections. Most appalling have been the allegations questioning the legality of information dissemination as underwriters secretly gave "cautious" revenue forecasts to some institutions (information unknown to the general public), while they simultaneously persuaded the public to purchase the stock. This automatically violates Regulation Fair Disclosure.
Uncertainty Plus Risk
Between now and May 18, 2013, over 1.2 billion lock-up expirations will allow employees, early investors, and others involved in the IPO to sell their holdings. Some investors who are waiting for this lock-up period to expire are Russian Internet companies Mail.ru Group and DST Global, which currently hold 47 million shares. This could turn into chaos if all individuals decided to dump their shares into the market when their lock-up expiration arrives. If the stock continues to tumble, which I believe will be the case, the psychological impact on many investors' emotions will be to simply dump their holdings to cut their losses, which can and will pressure other investors to do the same.
On top of this, major advertisers will not be spending as many advertising dollars as they had initially predicted on the renowned social networking platform. Also, the lead underwriter has downgraded the stock recently. Are they finally accepting that this IPO was handled badly?
Capital IQ analyst revenue and EPS consensus for the next five years are aggressive and unsustainable based on the current stock performance and uncertain business prospects for Facebook. One of the reasons the stock has tumbled more than 50% is because there's no demand. With an additional 1.2 billion shares in the market, the supply and demand theory tells us the price must decline in order to meet the greater supply. This is not rocket science. Due to the previously alluded to factors, I believe Facebook's shares can drop as low as $10.
With a 30% year-over-year increase in EPS, a more conservative approach than Capital IQ's 40% EPS growth consensus, and a required rate of return of 30% to discount the future share price into today's value, I arrived at a valuation per share of just over $10. Keep in mind that this is an unproven medium, thus the market can be highly disappointed for giving Facebook higher trading multiples than Google (GOOG) and Apple (AAPL), both established, proven, and profitable businesses. For example, over the last 12 months, for every $1 in revenue the market is giving Facebook $6.60 in total enterprise value, while Google and Apple are getting $4.40 and $4.10, respectively.
My conservative projections may be inaccurate -- management could execute with velocity, efficiency, and find a lucrative and solid advertising model and make the world a better connected place. Meanwhile, I admit that I refuse to purchase the stock until it is trading near $10, until management figures out how to monetize its mobile platform, until it reports the next two quarterly earnings, and as soon as I perceive the company will take more advertising dollars away from Google, Apple, Microsoft (MSFT), and Yahoo (YHOO).
Zuckerberg is not alone. Other new struggling IPOs in the tech scene are Zynga (ZNGA) and Groupon (GRPN), both of which have had their share of scandals as their stocks have also tumbled and top executives have been resigning at both firms. Evidently it is going to take some time before Facebook and these new publicly traded companies can compete fiercely with established advertising giants such as Microsoft, Google, and Apple.
With such uncertain and risky future, there's no doubt Facebook's stock can continue to drop into the low double digits. In addition, it can lose top talent if the stock continues on a bearish trend and the business model fails to satisfy shareholder's expected returns. Currently, the employment agreements with Sandberg and other top executives have no specific duration and constitute at-will employment. Due to the stock's dismal performance and Facebook's precarious business prospects going forward, other top executives could be tempted to leave the company and pursue other endeavors.