Facebook Not The Worst IPO Ever

By Stephen D. Simpson, CFA | August 23, 2012 AAA

Hyperbole is very nearly the oxygen of the financial writer, and so it's surprising to see plenty of doom and gloom around Facebook (Nasdaq:FB) these days. The stock has very definitely underperformed since it went public, and the expiration of the first lock-up period (and potentially 271 million shares up for sale) may only make it worse. Whether Facebook goes down as the worst IPO ever is a story that is far from written, but investors would do well to pay attention to the lessons it has already offered.

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A Rocky Start
Facebook is not off to a great start as a public company. From its initial IPO price of $38, Facebook did trade as high as $45, but now stands at roughly 50% of its IPO price. This is problematic on multiple fronts. With the initial lock-up now expiring, it is not at all improbable that institutional investors will punt their shares, take their losses and move on to greener passages. It's also worth noting that this could get worse before it gets better - investors could look to close losing positions ahead of the next quarterly reporting period (window dressing) or before the end of the year to take the capital loss.

SEE: A Primer On Investing In The Tech Industry

What Did Facebook Do Wrong?
As is often the case with hot and heavily hyped tech stocks, Facebook hasn't necessarily done anything wrong on its own. The company's model is what it is, and investors made their own decisions about how to value that model. Along those lines, while Facebook might fairly be accused of not following the conservative mantra of "under-promise and over-deliver", I don't think it's fair to say that the company misled anybody about its model or short-term performance metrics.

Instead, I think investors are waking up to the reality of what Facebook is and what Facebook offers. Facebook users are not the customer, they are the product, and Facebook is basically just another company trying to build a business around internet advertising. As somebody who writes a lot for sites based around ad revenue, I can tell you that's not the easiest model. That said, the company has to prove that it has a model that can work as well on mobile platforms as it has to date on more traditional platforms.

It's also worth noting that the entire internet space has had its challenges this year. Groupon (Nasdaq:GRPN) and Yelp (NYSE:YELP) have been quite weak during Facebook's time as a public company, while Google has basically flatlined - all while the Nasdaq is up nearly 20%. Now you could argue that Facebook's struggles have pulled others down with it, but I think you can make an equally solid argument that downward earnings revisions at Groupon and Yelp reflect a tougher operating environment (even allowing for the clear differences in business models and markets).

It's Not Over Yet
Facebook's debut has been unimpressive, but the question remains whether anybody will care in another year (or five ... or 10). After all, the stocks of well-known tech companies like Google (Nasdaq:GOOG) and VMware (NYSE:VMW) had their initial challenges, and Vonage (NYSE:VG) was practically a case study in how badly wrong an IPO can go. Said differently, it is a mistake to talk about Facebook as belonging to the same group as Pets.com or Webvan - companies that went public with terrible business models, which flamed out when they could no longer go to the market for additional capital.

SEE: The Biggest IPO Flops

There are risks that Facebook will see pushback on ad pricing, revolts from users on more obvious revenue generation attempts, and perhaps just a general staling of the whole experience. But it's not as though this is a reproduction of the 2000-era Underpants Gnome internet company business model (Step 1 - acquire customers/users; Step 2 - ???; Step 3 - profits!).

The Bottom Line
To be very clear, I'm not trying to make the case that Facebook's post-IPO malaise is unfair or that the stock is somehow now a great bargain. I don't believe that for a second. Rather, I believe that the frothy stories about whether Facebook marks the end of the social media bubble (if there was one) and/or is the "worst IPO ever" are more targeted at generating clicks than offering any explanation as to what's going on at Facebook and what could be in store.

I think Facebook will continue to find success in monetizing its user base and faces little immediate threat from rivals like Google. With time, I also believe that investor expectations will become more rational, and the price on Facebook shares will settle down. In the meantime, though, I expect these shares to remain highly volatile - as any hint of good/bad news will energize a fierce tug-of-war between investors who think Facebook is the latest greatest play on an emergent tech trend and those who believe valuation always matters in the end.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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