On Wednesday, June 6, at precisely 10:00 a.m. EDT, a major moment for the stock market may have been marked. That's when shares of Facebook (Nasdaq: FB) fell to $25.52 before turning up. For folks that bought into the IPO, hopes are building that this price marks the all-time low and that it's all uphill from here.
For the thousands of investors that passed on the IPO but have been watching for signs of an entry point, that intra-day bottom is also being eyed. Will it hold? Time will tell, but the time has surely come to figure out what this business is really worth.
In roughly two weeks, the investment banks that brought Facebook public will issue their initial reports on the company. You can be sure these analysts will generally gush about the stock, as they will be enlisted to help their firms save face, suggesting the stock is still a great one to own.
I've been reading three reports, and each has a unique conclusion. Let's take a closer look.
1. Bernstein Research: $25
This is one of the most respected research firms on Wall Street, in part because the firm doesn't underwrite IPOs and has no research conflicts. Bernstein's take: Facebook is dead money. The key concern is one many investors have: "We believe there is material risk that over the next 12 months investors will question Facebook's ability to achieve our forecasted 2013 revenues (of $6.44 billion) as near-term revenue growth decelerates." This revenue base implies roughly 30% over the 2012 forecasts of $5 billion, and will only come if Facebook succeeds in boosting fees for existing corporate users without alienating them in the process.
To be sure, Facebook's second-quarter is likely to be quite good. Newly-public companies always aim to pack a bunch of good news into their first earnings report. Often times, it's the quarter after that when reality sets in.
Bernstein's Carlos Kirjner spends 39 pages detailing the company's positioning in both social advertising and display advertising, and thinks it will be the latter that emerges as the company's long-term strength. The recent decision by GM (NYSE: GM) to pull a $10 million social advertising campaign from Facebook highlights this uncertainty. If Kirjner is wrong and social advertising eventually emerges as a key alternative to Google's (Nasdaq: GOOG) massive display ad business, then he concedes that shares would trade up into the low $30s.
2. Pivotal Research: $30 price target
This firm initially picked up coverage a few weeks ago with a "sell" rating, noting that the projected $42 post IPO price was just too rich. They upgraded that rating on May 31 to "hold," as shares had already fallen below that $30 target. Echoing Bernstein's comments, they note investors have "increasingly incorporated diminished/lumpy revenue expectations for revenue growth for the next several quarters." Indeed, part of the recent controversy around the IPO involved alleged communications from the investment bankers to favored clients that Facebook's near-term revenue projections were too optimistic.
Analysts at Pivotal lay out several near-term concerns beyond the revenue issues, including:
More than $2 billion in 2012 capital spending which may not be embedded in many forecasts.
"The likelihood of continued acquisitions without a definitive investment return profile."
and rising operating expenses that investors may be underestimating.
It's the second bullet point that has me greatly concerned. Facebook shelled out $1 billion (in cash and stock) for photo-sharing site Instagram in early April, which is an absurd purchase price. This creates the concern that management will be reckless in deploying the company's cash and shares.
But Pivotal's analysts, as is the case with Bernstein's Kirjner, also draw a brighter long-term conclusion: They say investors will fully digest the near-term challenges as 2012 winds down. "Facebook by then will have cycled through difficult comps and investors can better focus on the fundamental growth story."
3. JMP Securities: $37 price target
I should caution that this firm has never met a tech stock it doesn't like. Only 2% of the 359 companies it currently follows are rated a "sell." That said, they say shares will smartly rebound when the investor focus pivots away from the 2012 challenges and back to the long-term opportunity for what is still a revolutionary company. Investors "shouldn't underestimate Facebook's highly creative management team, its large user base, the virtuous circle created by its size to attract more users, and the attractiveness of such a large user base to advertisers," they say, adding that Facebook's current 11% share of the roughly $30 billion worldwide display ad market could grow to 22% by 2015.
So how do they arrive at that price target (which represents 50% upside)? Well, with several large grains of salt. They say shares should sport a price-to-earnings (P/E) ratio that is 50% higher than the three-year earnings growth rate of 36%. This means shares should be valued at 54 times projected 2013 earnings per share (EPS) of $0.68. My take: that's a bull market P/E ratio, and we're not in a bull market right now.
Risks to Consider: It's all about the next few quarters. Facebook is coming up against very strong comparisons with year-ago quarterly results, and unless this year's quarterly results are stellar, investors may conclude that lofty long-term growth targets will be unattainable.
Action to Take --> After reading all three of these reports, I can draw a fairly nuanced outlook: Facebook is a near-term buy, a medium-term sell and a long-term buy.
In the near-term (on or around June 25), the underwriting analysts will gush that this is the best company they've ever seen. That could give a solid lift to the stock. Roughly a month later, Facebook will delivered second-quarter results and forward guidance that may be underwhelming (if these analysts are correct). This suggests booking profits if shares rebound in coming weeks. Yet over the long-term, there's a real chance Facebook will find many levers to growth.
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