Facebook's Price Finally More Reasonable?

By Jonathan Yates - August 1, 2012 | Tickers: FB, GRPN, LNKD, OPEN, ZNGA | 0 Comments

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Hearing about a company before it goes public is like listening to someone talk about their high school football career.  Invariably, they were a running back with break-away speed and pro potential...until they blew out their knee in a pre-season scrimmage.

Now being carted off the field after its first full contact session as a publicly traded company is Facebook (NASDAQ: FB), now under $24 a share, a new low, as Wall Street knee-capped the stock due to a disappointing earnings report with no positive forward guidance.

Not that long ago, Facebook hits its year high of $45.  That was a nice breakaway run from its initial public offering price of $38 a share.  As the market has obviously responded, that level of pricing was way too high for Facebook. 

For the new share price level for Facebook, the lowest of any target range from the analysts covering the company is $25: been there, done that as it closed at $23.71.  What will be instructional to see is if any new buy recommendations come out from analysts after the stock hit a new low since its initial public offering on May 18.  Many times that will happen, particularly for a company with the investor appeal of Facebook. 

There were none on Friday, which was very telling, in the short term.  If no new analyst upgrades come out soon for Facebook, that is a very bearish sign.  Recommendations from Needam, RBC Capital Markets and Oppenheimer all set a target price of $40 or higher for Facebook.  In correspondence with potential investors before the initial public offering, Felix Investments stated that it expected to sell its Facebook shares for a price that would be “north of $100” in November of this year.

But the recent earnings report from Facebook has greatly diminished the allure of the company that was spawned from the dorm rooms of Harvard Yard.  Facebook shares closed down 12% after it reported late Thursday that it swung to a second-quarter loss of $157 million, or 8 cents a share, from a net income of $240 million or 11 cents a share from the 2011 period along with adjusted earnings at $295 million, 12 cents a share, and revenue increasing by 32% to $1.18 billion.

Very bullish from the earnings report for Facebook is its increasing ad revenue.  Facebook's ad revenue grew 28% in Q2 2012, the great majority from its core desktop ad unit.  In June, Facebook launched mobile advertising solutions.  The Facebook Ad Exchange is now in its beta phase, with robust advertiser interest cited.  The potential market for this, notes Facebook, is $2 billion alone for just the United States.  It was also reported that Facebook's ad rates have increased by 9%, another positive sign. 

In response and despite the stock plunge, Sterne Agee analyst Arvind Bhatia maintained his Buy rating for Facebook, observing that the company hurt itself with no forecasting.  This, according to Bhatia, "Lack of forward guidance put pressure on shares.   However, we think Facebook's market opportunity remains large and the stock should be a core holding in tech portfolios with a long-term horizon." Bhatia also lowered his price target from $46 to $37, buttressing his continued Buy rating by noting that revenues should increase from greater utilization of Facebook's Premium Ads and Sponsored Stories to enhance cash flow. 

While Facebook obviously has its bulls, haters abound.  There is a short float of 13.46%.  A short float of 5% is considered to be troubling for a company.  The double digit drop in the share price of Facebook last week when earnings were reported triggered the NASDAQ short circuit trigger breaker...not a good sign.  This is required, according to the Securities and Exchange Commission, as "When triggered, it will prevent short selling, including potentially manipulative or abusive short selling, from driving down further the price of a security that has already experienced a significant intraday price decline, and will facilitate the ability of long sellers to sell first upon such a decline."

Judging from where other social media stocks are in relation to the initial public offering price, Facebook should rally.   Facebook is making money, with a profit margin of 26.95%; and earnings-per-share growth is up 79.57% for the year; and expected to increase by 30% next year.  These financials compare well with other companies in the social media sector.

LinkedIn (NYSE: LNKD), a social media stock that has held up well, has a profit margin of just 2.40% with earnings per share growth of 247.% this year; 83.33% projected for the year after that (those numbers are obviously unsustainable, in addition Facebook will be competing directly for the business professional demographic).  For Groupon (NASDAQ: GRPN), the profit margin is a negative 10% with earnings-per-share down by 44.10% this year.  The profit margin at Zynga (NASDAQ: ZNGA) is also negative at 41.73% with earnings-per-share falling more than 500%.  Open Table (NASDAQ: OPEN) has a profit margin of 15.28% with an increase of 51.12% in the yearly earnings-per-share growth.

Now trading around more than one-third below its initial offering price, the mean analyst target price for Facebook over the next year is $38.  That should please the Alanis Morissette in all of us as that was the initial public offering price for Facebook...isn't it ironic!

To reach that level, Facebook will have to improve earnings over the next four quarters.  If not, it will remain in the low $20s or decline even more.  One way or another, over the next year the market will dictate what the viable initial IPO price should have been for the shares of Facebook.

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