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.
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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.
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.
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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
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.