Following Up on the Facebook Fiasco
I posted almost a year ago on why I thought Facebook stock was a really bad investment. Unfortunately for investors, it was even worse than I had anticipated. The Facebook IPO mania has given way to a massive case of buyer’s remorse for investors. No matter how much I Like connecting on Facebook, I won’t be Friending this stock any time soon.
Check Out: 4 Important Lessons on Investing
The Question of Value
The 100 billion dollar question is, what is Facebook really worth? Yes, they have 800 million users and are extremely popular. But, does their future revenue justify such a high valuation for the company? Is it really more valuable than Google, Starbucks, McDonald’s and a host of other established businesses? Before the IPO, many investors and analysts believed it was. Now, they aren’t so sure. It never was, in my opinion.
The key indicator of value is potential future earnings. Without earnings, a company is just one big expense. The bad news for investors is Facebook’s earnings estimates have been recently cut, in a sneaky way by the underwriting banks. High-profile advertisers, such as GM, have pulled their advertising campaigns. The Facebook ads weren’t generating enough sales to justify the cost. Internet advertising isn’t always profitable and that could be a huge problem for Facebook and their shareholders.
Check Out: Facebook Bankers Secretly Cut Revenue Estimates
Wall Street vs. Main Street
The small investor rarely gets an even break on Wall Street and the Facebook IPO is a prime example of how they are played as pigeons. First, Facebook shares have been trading in private long before the IPO. Of course, these shares were only available to the preferred customers of some of the investment banks. When the IPO finally launched a half hour late, most of the shares went to institutional customers of the investment banks. Meanwhile, orders from some discount brokers went unfulfilled for more than two hours.
The most obvious and under-handed way small investors were swindled in the IPO, was by the lack of notice of the earnings cuts. According to Reuters, there was “selective dissemination” of this information, which means insiders were told, but others weren’t. Since analysts from the underwriting banks all cut their earnings estimates at the same time, they must have known something bad was going on. Yet, they only told a privileged few, while most investors were left in the dark.
Check Out: Facebook Share Price Plunges Again
Train Wreck Ahead
The Facebook IPO was so poorly handled that it was bound to attract investor lawsuits and the scrutiny of regulators. Lawsuits have already been filed in many states against Facebook executives and the investment banks that underwrote the IPO. The NASDAQ is even being sued over the inability of the exchange to process orders. The SEC and FINRA are investigating the selective dissemination of the earnings cuts and problems with order processing. This is going to take quite a while to sort out.
It looks like the lawyers are going to be the big winners on this IPO. Investors have already lost $19 billion and I predict this is only the beginning. Even if revenue grows according to estimates, the stock is currently trading at a forward P/E ratio of 60, which is about three times as high as it should. The company’s management is going to be distracted by lawsuits and regulators for months to come. This comes at a critical time when they need to retain advertisers and secure new sources of revenue. If they start to lose members or fail to produce earnings, the stock price could plummet.
Check Out: Fury over Facebook IPO Grows, Lawsuits Mount
The Bottom Line
The bottom line is that Wall Street knows how to hype an IPO, to draw in naive investors. Facebook was the most over-hyped, over-valued and under-handed IPO I’ve seen in 25 years. The obvious lesson is that investors should have been fearful, instead of being greedy.
“If you don’t follow the stock market, you are missing some amazing drama.”
Mark Cuban – Owner of the Dallas Mavericks
Recommended Reading
Lazy Man and Money – Heard Anything Intersting about Facebook Lately?
The Biz of Life – Facebook IPO at $38 a Share, No Thanks
This post was featured on the Carnival of Personal Finance over at Good Financial Cents. If you aren’t familiar with the Carnival of Personal Finance, you need to check it out. It’s the best place on the web to get your financial advice.
As more and more information comes out about how this deal went down and the decisions that were made, it should become very apparent to even the most casual of observers that greed was the driving force throughout the entire process. While this may not come as a shock to most folks, the rather transparent nature of the greed in this case is definitely noteworthy.
Welcome Kevin,
Greed was definitely a factor for many and unbridled optimism for others. I think a lot of people just like Facebook so much they thought it would be cool to invest in.
“No matter how much I Like connecting on Facebook, I won’t be Friending this stock any time soon.” – Bret you’re a wordsmith. Well played!
The entire time I was seeing the valuation kicked around I was a bit paranoid. $100 billion, around 1 billion users – if the average account is worth $100, what’s my Facebook page worth?
Paul,
I have two Facebook accounts and a Page, so I must be worth at least $200.
I believe a lot of the growth is starting to come from Indonesia and other countries. One real question for advertisers is how valuable are the global users? Are they going to click on the ads and buy stuff?
I don’t see how they are going to get $100 in sales from most global users. Many are using Facebook mobile, which doesn’t convert advertising well.
Well said Bret, and the worst part is there’s worse to come. I still do not understand how average joe got sucked in into something so overvalued…friending this stock might turn out to be a very painful relationship.
Mich,
I keep thinking about how MySpace originally sold for $580 million and was liquidated for only $35 million at the end. The value at the Facebook IPO was almost 2,000 times as large. If users abandon the platform or a better service comes along, it won’t be worth much.
I did not buy in all that hype about Facebook. With the ever growing internet, who knows how long Facebook can still have value?
Hi Josh,
The Wall Street hype machine was on overdrive. The media really played it up too. They suckered in a lot of people.
There isn’t any complex technology in Facebook that couldn’t be quickly replicated by a competitor. They do have a massive user base, but they are fickle, non-paying users. They could flee at any time if Facebook starts to charge for the service or sells their personal information.
I think there was too much expectation of growth priced into the IPO. FB may ultimately prove that they can grow into that price. Time will tell. I’m too cautious to participate in this deal though, so I have to watch from the sidelines.
You are so right Roshawn.
I saw so many articles where people expected the stock price to quickly rise to $100. That would have been almost 8 times what the stock was worth, based on earnings.
It reminds me of the Greater Fool Theory, where people expected to sell the over-valued stock to someone else. Instead, they would up being the Greatest Fools and lost 30% of their investment.
Hi Bret, do you think if Facebook ads iron out their kinks and do start generating enough sales to justify the cost, the stock value will increase?
Hi Daniel,
There is no doubt that if Facebook generates enough revenue their stock price will rise. That’s what happened with Apple and Google. It’s the way the stock market is supposed to work.
Here is the problem with Facebook. Even after their stock has dropped 35%, they still have a trailing P/E ratio of 88:1. That’s 3-4 times as high as it should be. I have seen estimates that value their stock realistically around $12, based on current earnings.
So, they would need to triple their income just to support the current stock price and quadruple earnings to support what the stock originally sold for. They would need an even bigger revenue increase to make the stock take off and return a profit for investors.
Since analysts just slashed their earnings projections right before the IPO, it’s a long-shot. It could happen, but I wouldn’t bet the farm on it.
Maybe facebook should have remained a private company.