Facebook shares tumble 50 per cent since May IPO

It was a clear spring day when I was about to start my morning jog and I got a glimpse of a large Facebook logo on a bus stop shelter in St Julian’s. Being so early morning, I thought I was still dreaming but after rubbing my eyes once or twice, the large blue advert was still there. I quickly realised the aim was to promote the initial public offering of the world’s largest social networking site. The advert simply stated “Facebook is going public”.

Concerns about how the company can keep monetising the growing number of visitors accessing Facebook on their mobile devices pushed the share price downwards- Edward Rizzo

The advert dominated my thoughts through my eight-kilometre jog and it immediately dawned on me that the Facebook IPO frenzy had also hit our shores.

Various international business websites had been reporting about the long-anticipated IPO of Facebook for several weeks. However, I was not expecting this hype to also hit the Maltese investing community. The adverts resulted in some enquiries coming through our office that day in anticipation of the start of trading in Facebook shares on the Nasdaq on May 18.

The many international columnists who published articles about Facebook in the run-up to the IPO provided a good account of the brief but successful history of the social networking site since it was launched while Mark Zuckerberg was a Harvard University student in 2004 – the same year the previous largest internet IPO of Google came on offer.

The final pricing of Facebook’s share offering was established at $38 per share giving the company a total valuation of $104 billion. The significance of this valuation drew many comparisons as Facebook was attributed a value greater than Boeing (the world’s largest aircraft maker) and also larger than the combined values of Dell and Hewlett-Packard.

On the other hand, the $104 billion valuation was understandably below that of other longer-established and more profitable technology giants such as Google ($190 billion), Microsoft ($250 billion) and Apple at $425 billion. In the last full financial year to December 31, 2011, the prospectus published by Facebook in conjunction with the IPO revealed that the company generated total revenue of $3.7 billion and net profits of $1 billion.

As the $104 billion valuation was established, many commentators criticised the stratospheric price-to-earnings multiple of 100 times and immediately drew comparisons to the dot.com boom of 1999 and 2000 when many internet start-ups had similar valuation multiples. By comparison, the largest company today by market cap (Apple) is currently priced on a p/e multiple of less than 15 times which is far more sustainable than that of Facebook.

The valuation attributed to Facebook led to several calls for caution from several international analysts. Other commentators queried why the prospectus lacked adequate reasons for raising circa $6.8 billion in the IPO and also highlighted the risk that the ultimate control will remain in the hands of the founder and the CEO even after the flotation. Mark Zuckerberg retains almost 60 per cent of the voting power through his direct shareholding of just under 30 per cent in Facebook’s privileged ‘B’ shares and agreements with other voting shareholders controlling a further 30 per cent of the company. The CEO retained the right to appoint the directors and also the control over the management of the company.

The prospectus stated that “we do not have any specific uses for the net proceeds planned”. Facebook’s operational cash flow and current funding “will be sufficient to meet our operational needs for the foreseeable future”. So what does Facebook intend to do with the cash generated by the issuance of new shares as part of the IPO?

According to the documents presented during the IPO roadshow, the main reason for raising fresh equity, apart from meeting US regulations for a private company to go public when it has more than 500 shareholders, is to meet a tax obligation triggered by the listing.

The CEO was very categorical in a letter to the new shareholders claiming that another motivation behind the IPO also was to honour his commitment to his initial venture capital investors and the various employees who had a stake in the company.

According to one of the many books published about Facebook, among the initial shareholders was the person who had painted the walls in Facebook’s office. Rather than a cash settlement for the paint job performed, this person was allotted a number of shares in compensation. The IPO valuation provided him with a holding worth $200 million in Facebook shares.

The Facebook IPO valuation also created four new billionaires. Mark Zuckerberg’s net worth was estimated at over $17 billion prior to the IPO while one of his fellow co-founders, Dustin Moskowitz, was ranked as the youngest billionaire by Forbes magazine with a net worth of $3.5 billion.

Although the offering was successful, the initial days and months of Facebook as a publicly traded company have been very disappointing.

The commencement of trading on Nasdaq on May 18 was mired in controversy. Trading under the symbol FB was delayed for quite a while due to a series of technical failures by Nasdaq. When trading finally commenced, it was not until a couple of hours later that brokers were aware of the actual trades that took place.

Various investment banks actually received more shares than their clients had requested and this led to significant losses for these market makers as the share price dropped below the IPO level within the first few days. The Swiss banking group UBS recently claimed that the botched stock market listing of Facebook cost it circa $225 million.

The share price had touched a high of $45 on the first day but the euphoria quickly evaporated and the equity closed only minimally above the $38 IPO price. Facebook’s share price continued to decline and by mid-July it had dropped by 30 per cent. The company was under intense pressure to deliver a strong set of financial results on July 26 – the first results announcement since the IPO.

Facebook reported a 32 per cent rise in revenues to $1.2 billion in the second quarter of their financial year between April and June 2012. Although revenues had exceeded analysts’ estimates, the announcement failed to convince the market given the slowdown in growth compared to the 45 per cent increase in revenues in the previous quarter.

Facebook was spending more on technology and hiring of new employees while sales and marketing costs more than tripled to $392 million. However, the greatest disappointment was the lack of a sales or profit outlook for the current financial year by Zuckerberg during a conference call with Wall Street analysts shortly after the results publication.

The lack of an outlook for the year and concerns about how the company can keep increasing revenue and monetising the growing number of visitors accessing Facebook on their mobile devices pushed the share price downwards and touched a fresh low of $19.82 on August 2 – only a few days after the Q2 results announcement.

This represents a 48 per cent price drop on the IPO price level and a 56 per cent drop from the highest level of $45 reached on the stock market debut only three months ago.

Despite the $50 billion drop in the market valuation of the company which reflects the sharp decline in the share price since the IPO, Facebook remains the second-largest public company within the global internet sector behind Google Inc.

Facebook is likely to continue to receive a lot of attention in the press and also among investors and analysts. The focus is likely to be on the company’s success in generating higher revenues from its ever- increasing mobile audience as more than half of Facebook’s members (which totalled 955 million as at June 30) access the site on mobile devices.

Recent rumours also indicated that Facebook may plan a mobile handset in competition with Apple and the other large handset manufacturers but the CEO denied reports by arguing that it “wouldn’t make much sense for us”.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd, “RFC”, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the issuer/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.

© 2012 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.

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Mr Rizzo is a director at Rizzo, Farrugia & Co. (Stockbrokers) Ltd.