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This commentary is written by independent finance journalist James Dunn. The title is Fundamentals Faze Facebook Float
It was first published on Friday 25 May 2012
And is read by Michael Mullins
Please remember that advice in this podcast represents a general view. It is recommended that you seek specific financial advice, before making investment decisions.
The initial public offering (IPO) of Facebook, Inc. this month was the latest in a long line of experiences that showed share investors, yet again, that there is a big difference between a company's product, and its stock.
Facebook, the product, is undoubtedly a phenomenon. The social media site has close to one billion users. According to digital business analytics firm ComScore, Facebook accounts for 14 per cent of time spent online globally. What started out eight years ago as a fun distraction now dominates the Internet: Facebook surpassed Google's traffic in March 2010.
In February 2012, Facebook announced plans to sell stock on the public markets for the first time, with the IPO - what Australians would call the 'float' - scheduled for May. Facebook said it would sell about US$16 billion of stock - 5 per cent of the company - in the third-largest US IPO ever, behind GM and Visa, placing Facebook immediately among the top 25 companies in the US. So many people wanted to read Facebook's offering documents (that is, the prospectus) that the US Securities and Exchange Commission website crashed.
What we had was a cultural phenomenon coming to the stock market. It was inevitable the IPO would be hyped.
Facebook priced its shares at US$38 a share on May 17. On May 18, wearing his trademark hoodie, founder and chief executive Mark Zuckerberg rang the bell (virtually, of course) to kick off Nasdaq trading, and his company's float.
This was the point where the pedal of hype hit the metal of the stock market. And the float process did not go smoothly - to put it mildly.
First, technical glitches in the Nasdaq system delayed the opening trades: there are lawsuits over this from aggrieved investors (Zuckerberg is reported to be moving the company's listing across town to the New York Stock Exchange as a result.)
Then, the size of the float was increased by 25 per cent in the final days. Next, the 'greenshoe' arrangement - which allows the vendor or its underwriting panel to buy in the secondary (post-listing) market more shares than were offered through the prospectus, and is meant to support the share price - effectively allowed the underwriters to 'short' the stock, and make money. Which Morgan Stanley, the lead underwriter, appeared to do.
Then came reports that Morgan Stanley selectively circulated negative analyst reports - which highlighted lower revenue estimates - about Facebook among favoured clients before the float.
The upshot of the schemozzle is that Facebook sank 18 per cent in its first four days on the market: at time of writing it was 15 per cent below the $38.23 at which it closed its first day.
For most investors, the bungled float and the allegations of preferential treatment for some large players have left a bad taste in the mouth. Worse, they are sitting on a stock that is worth less than what they paid for it.
The problem is that now, Facebook is a listed stock and like all of its peers, it has to make money and generate a return.
Facebook has massive potential for revenue, mostly based around selling targeted ads to its user base. In the jargon of business, this would “monetise” the asset that the user base represents. How well it does this will decide whether Facebook delivers the revenue growth that justifies its valuation.
Clearly, plenty of investors wanted the stock because it is Facebook. But the professional investment community was not wholly fans of the stock at the asking price.
According to Wall Street broker estimates collated and analysed by Thomson Reuters StarMine, Facebook's estimated annualised earnings growth over the next ten years is put at 10.8 per cent. But the problem, says Thomson Reuters StarMine, is that the IPO price implies growth of 24 per cent. Thomson Reuters StarMine estimates Facebook's intrinsic value - Warren Buffett's favoured measurement - at $9.59 a share.
The company itself is concerned about not being able to grow as much as its investors expect. Facebook's own IPO documents stated the risks clearly, saying, among other caveats, “We may not be successful in our efforts to grow and further monetize the Facebook Platform,” and, “We cannot assure you that we will effectively manage our growth.”
How many retail investors read and digested those statements? Or did their homework on the growth rates implied by Facebook's valuation? Facebook may well pull off all of that growth rate, and more, over the long term. But in the short term, the IPO was a triumph of hype over substance. Too often, investors fall for that.
In any float, if you are interested in paying for a company's growth prospects, you are better to wait for the market itself to confirm its faith in those prospects.
And that concludes the column
Fundamentals Faze Facebook Float
from independent financial journalist James Dunn.
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Please remember that advice in this podcast represents a general view. It is recommended that you seek specific financial advice, before making investment decisions. The views expressed are those of James Dunn not necessarily Vanguard’s.