Facebook Shares are not a Buy…Until Proven Otherwise

Founded in Harvard University’s dorm room by Mark Zuckerberg and his friends, Facebook is the leading social networking site and the behemoth in it’s respective industry. It has over 900 million active users as in April of 2012. The growth chart is phenomenal and mind-boggling that make it oh so tempting to buy into.

In 9 years, Facebook has come a long way – from Harvard University’s dorm to it’s IPO.

It’s been a number game for Mark ever since Facebook was launched. Though Facebook wasn’t commercialized initially, it later went on to earn billions of dollars just from ad revenues. In 2010, Facebook made revenues of $2 billion, and in the year 2011, revenues jumped to $4.7 billion.

Considering the massive growth in the user base and the earnings, Facebook decided to go public in the year 2012. And on May 18th 2012, at 11:30 am EDT, Mark Zuckerberg rang the “NASDAQ bell” and stock was up for sale at a share price of $38.

First day of trading witnessed an amazing response from investors. With 82 million shares in first 30 seconds and 110 million shares in the first seven minutes, Facebook managed to trade 458 million shares exceeding any other company ever listed on NASDAQ. From an opening $38 per share to $45 in few hours, it was an overwhelming ride for Facebook holders.

Things went as scripted on day one, but didn’t go as planned on day two. Facebook shares failed to get any traction. The value kept falling ever since then. It fell to a low of $27. So what went wrong with Facebook IPO? Was it valuation, planning, timing or something else? What led to the disaster of Facebook shares?

Over Valuation

To value Facebook, bankers and investors have to value millions of users, their status updates, photos, likes, and videos. But to date no one really knows how to value the users. Facebook and its lead investment bank Morgan Stanley broke all barriers and valued the company at a staggering $104 billion.

After the valuation, before the IPO, the share price was set at $28-$35, but all of a sudden the offer price was upped to $38 on the trading day. The problem didn’t arise because the share price was over-valued at the last minute, but because the overall company was overvalued. It was valued much higher than it actually should be.

What raises a red flag for investors? Ad revenues remain the only source of income for Facebook.

The NASDAQ Issue

The NASDAQ issue also had an impact on Facebook trading and downfall of the share value in just few hours. The exchange that trades Facebook shares wasn’t ready to handle huge volume trading, as a result, the stock hit the market late by 30 minutes. This led to the increase in share value from $38 to $42.

Though people invested without realizing what they were paying for in the first go around, later realized that the share value isn’t worth $42 a pop. Thus, trading went down and so did the price. This was unexpected for these so called optimists investors.

Revenue Source

According to an article published on BBC on May 17, 2012, Facebook generates only $5 per every user. This means its total revenues are around $4 billion. Whereas, being valued at a jaw-dropping $104 billion, Facebook now has to generate at least $30b-$40b (holy S#!@) in order to support the valuation and to keep the investors happy.

Currently the situation looks gloomy as Facebook is struggling with law suits and with the IPO disaster.

So now, with so much going around in the Facebook world – from falling share prices to lawsuits to decrease in the net worth of Mark Zuckerberg, do you think it’s worth it to invest in Facebook? Here’s something to help you decide:

• About 44% of the total Facebook users have never clicked on ads. Whatever the reason is, they never have clicked nor do they intend to do so.

• General Motors, one of the giants in the automobile industry, has earlier allotted $10 million budget for Facebook advertising. But now it wants to pull back the investment.

• As mentioned earlier, Facebook makes an income of only $5 per user per year, which is way too less when compared to $100 billion valuation.

• The only source of revenues is advertising. If it wishes to continue the growth, it should find more ways to earn.

• Facebook also has to focus on increasing the user base because 50 – 60% of its users are from North American and Europe and only 10-15% from Asia. Though there are about 4.3 billion people living in Asia, the number of Facebook users are way too less. While the growth of Facebook in India is 132%, China has a near-zero penetration rate.

• The biggest hurdle in Facebook’s growth could be its privacy policy. This in turn might impact the share value in the market.

Investing in Facebook shares doesn’t look too profitable at the moment considering the Tom and Jerry run in the stock market. But if Facebook fixes the underlying problems and comes up with new revenue models, then it would be worth it to invest.

The Verdict

‘Wait and see’ policy seems to be working right now for the investors, fund managers, banks, and corporate companies. It’s a sensible idea to hold the investment until Facebook increases its revenues at least five-folds. At the end we would say, Facebook shares are not a buy…until proven otherwise.