This weekend, Barron's published a bearish front-page article on Facebook (FB). Not surprisingly, the stock sold off 9% as the weekend-worriers took their profits. I think this headline driven sell-off provides a good entry point for long-term investors.
No New "News"
The Barron's story seemed to rattle traders today, as 80 million shares traded (twice the normal daily volume). But substantively, there was not much "fresh news" in the article. Here are several key points in the piece:
1. The transition to mobile ads will be challenging.
2. Facebook trades at 36 times 2013 earnings, while competitor Google (GOOG) trades at half that multiple.
3. Facebook shares are worth $15 if you use Google's P/E multiple.
4. The lock-up for 1 billion shares will expire in several weeks
While these are mostly valid points, not one of them can be considered a new data point to the Facebook story. The only difference is these well-known issues were placed on the front page of a respected news publication. Thus, today's stock drop seems to be driven more by technical than fundamental factors.
Barron's Valuation Analysis: A Head-Scratcher
When performing a P/E valuation, it is crucial to compare companies with similar risk and growth prospects. Barron's did not do that here. They compared competitors with similar risks but dissimilar growth prospects. Specifically, Barron's arrives at its $15 price target by applying Google's P/E multiple to Facebook's EPS estimate.
Analysts expect Facebook to grow earnings at 25% a year, while they expect Google to grow at a respectable, but more moderate, 15% a year. Now, if you believe Facebook will grow at 15% a year, then sure, Barron's price target of $15 makes sense. Given Facebook's consensus growth rate is 25%, Barron's would at least need to explain whether or why it believes that Facebook's growth rate is unachievable.
Lock-up Expiry: Point Taken
The lock-up expiry will more than double share float from 692 million to 1.7 billion shares. The concern is that, over the short-term, there will be motivated sellers. True, but this is a good thing for long-term investors -- we know that there will be individuals selling for liquidity rather than fundamental reasons.
If you're waiting for the bottom to buy shares, realize it's tough to time the bottom for these typical of liquidity-driven sales. The reality is no one knows how many employees will sell their shares nor, importantly, how low the price will go. But we do know the selling is likely a temporary technical effect unrelated to long-term fundamentals. In other words, this lock-up event is a good entry point for long-horizon investors.
Assuming consensus growth rates, Facebook today is reasonably priced. Barron's valuation analysis is correct if you agree that Facebook's growth rate is 15% rather than the analysts' estimated 25% growth rate. To me, Barron's price target seems like a low-ball estimate lacking substantive support.
While the lock-up expiration will likely bring short-term selling pressure, I view this as a buying opportunity. Long-term investors can consider purchasing shares gradually over the next few weeks, or sell to open put options today.