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Understanding the Facebook IPO Drama: Why has Facebook’s Stock Price Gone Down Since the IPO? Should I Buy Now?

Sept. 5, 2012
Investing, Investments
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By Susan Lyon

Silicon Valley’s interwebs and tech blogs blew up yesterday with (quiet, electronic) shouting over the aftermath of Facebook’s IPO and whose fault it all was – crashing stock and all that jazz.

Here’s the play by play of the Facebook IPO Timeline:

  • Facebook held its initial public offering on May 18, 2012 for a price of $38 per share, raising $16 billion.  Stock began trading at $42.05 a share.
  • By May 29, just 11 days later, Facebook’s stock had declined to its first sub-30 price of $29.16.
  • As analysts began doubting that Facebook’s ad revenue model was as effective as other ad giants like Google, the stock continued to decline.
  • On August 2, a Facebook SEC filing revealed that as many as 83 million of its reported 955 million members could be fakes or duplicates; Facebook’s stock dropped 4.02% that day down to $20.04.
  • Facebook shares hit a new low of $17.58 a share on September 4, 2012, the lowest point since the company went public.
  • Andrew Ross Sorkin wrote a harsh piece on Monday for the New York Times DealBook that criticizes David Ebersman, Facebook’s Chief Financial Officer, for the company’s post-IPO downfall and blames him for the company’s crashing stock prices because he misdetermined the price and value of the IPO.
  • Mark Cuban, owner of the Dallas Mavericks and Chairman of HDNet, quickly responded in an equally harsh Huffington Post blog post arguing that Sorkin’s take was “just ridiculous” because it is not within Ebersman’s job description to manage the portfolios of Facebook investors and day traders, he cannot be held accountable for stock losses of individuals who chose to invest.
  • Mark Zuckerberg then pledged to hold onto his Facebook shares for at least another year, making the company’s stock (FB) jump up 4.8% on September 5.  But that doesn’t change the fact that the stock still has quite a bit of work to do to rebound.

Is Facebook the Next Big Tech Meltdown?

Everybody likes a scapegoat, and we’ve seen it time and time again.  From Enron to Lehman Brothers, there was certainly a fair amount of blame to go around.  But Facebook isn’t even in the same boat as these guys, not to mention in the same ocean: that there is even a discussion around blame and fault seems a little misplaced to us!

The current chatter in this week’s tech media is blowing everything out of proportion.  The company isn’t tanking – just its stock is.  Despite this, the company is doing all right:

  • Facebook has reported a strong showing of 32% revenue growth in its first public earnings report, slightly exceeding expectations;
  • Facebook has a strong balance sheet having secured $10 billion in funding in its IPO;
  • Facebook is energetically testing and implementing new ad units focused around mobile that will address its past and current ad monetization problems that led to investor and analyst doubts to begin with;
  • Facebook is continuing to innovate elsewhere too, including in the mobile products space.  For one, the company has released a newly redesigned iPhone app that gets dramatically improved reviews.

Facebook may not be the next Google, but believe us: the company is certainly keeping a sharp eye on increasing its ad revenues.

NerdWallet’s Take: Proceed with caution

Any seasoned investor will tell you that past growth and pricing cannot be used to predict future value, growth, or stock success.  If it were that simple, investing in the markets wouldn’t be such a wild ride.  While it’s easy to get caught up in the hype, responsible investors should remember these basics:

  • Follow the fundamentals: Analysts warned early on that Facebook was overvalued based on fundamentals.  Individual investors had access to this information all along, but many chose to ignore the basics to buy the latest hot stock.  If you’re considering buying Facebook stock now, make sure you take the time to understand the company’s earnings prospects by thoroughly researching their financial statements.
  • Don’t try to time markets: Entire volumes of literature exist on behavioral finance and trying to predict waves of public optimism and pessimism to buy and sell accordingly.  Research shows that almost nobody can do this.  If you do decide to buy Facebook stock, plan to buy and hold for an extended period.
  • Diversify: Social media marketing has been all the rage in 2012 so far, and some have speculated that a new tech bubble is forming.  Betting the farm on one stock is bad investing.  Always make sure your portfolio contains a variety of assets – more on that later.

Expert Opinions: Looking Beyond Facebook

Rather than take sides like everyone else, we thought it would be more interesting to ask the IPO and social network experts what really happened – and what it means for laypeople and new investors as they watch events unfold.

  • Professor Itzhak Ben-David, Assistant Professor of Finance at Ohio State University’s Fisher College of Business, explains how behavioral finance has shaped Facebook’s stock struggles in light of the findings of his IPO performance research:

“There is clear evidence for behavioral finance playing a role when it comes to post-IPO performance, especially since there is strong historical evidence showing that on average IPOs underperform in the first year. There are a few general reasons this initial rollercoaster occurs:

  • IPO stocks are overvalued due to investor hype, such as the hype around the Instagram purchase just before the Facebook IPO;
  • Management teams massage the accounting numbers to make growth appear stronger than it really is;
  • There is price pressuring of insiders and institutional investors to sell their shares, such as when the lockup period expires. Although the lockup expiry date is well known in advance, it seems to always catch investors by surprise.

Laypeople must learn from this situation that is hard to forecast the performance of an individual stock – but that the evidence shows that historically IPOs on average underperform.  The sad thing is that investors do not seem to learn this over time.”

  • Sam Hamadeh, Founder and CEO of the financial data provider PrivCo, reminds novice traders of the critical difference between an attractive product and a smart investment:
  • “Investors should learn first and foremost that a great product does not necessarily make a great investment.   In fact, even a great business doesn’t necessarily make for a great investment.  Inexperienced investors often make the mistake of ignoring a company’s valuation because they use and love the product – whether it’s Facebook, Angie’s List, a sports team IPO like Manchester United, or other.  PrivCo always advises IPO investors that ‘Valuation Matters,’ and the case study of the Facebook IPO proves that lesson: great company, even great business, but materially overvalued and therefore a very poor investment.
    • For instance: would you buy a house you love no matter what the asking price?  Of course not!  If the asking price is wildly unreasonable, you have to drive on by and admire it from afar.
  • In PrivCo’s opinion, Facebook’s online ad revenue model has risks, in part due to the rapid shift to mobile device usage, but also because even the smartest companies have had difficulty building very valuable businesses based entirely on online advertising.  The price competition in online ads is just too high, and there tends to be a race to the bottom.   And while Facebook’s demographic user targeting is nice, the fact is that most of that can mostly already be done on Google, on AOL, on the, and so on.   So yes, Facebook’s online ad revenue model is risky, and certainly does not justify even its current reduced valuation, which is still rich in PrivCo’s opinion.”