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Monday, August 13, 2012

Facebook, revisited

from Megan Lisa Jones





Debacle?

It shouldn’t be. The company, less than 10 years old, still has a market cap of almost $50 billion. Still, the stock closed at $21.81 Friday, down around 40 percent from its IPO price of not many weeks ago. It has a drastically higher price to earnings ratio than Google, larger, which appears to be growing faster at this point. Most recent earnings reports from Facebook and partner Zynga, responsible for a portion of Facebook revenues, under whelmed.

Expiring lock-ups will lead to over 2 billion Facebook shares being available for sale within the next 4 months. Meanwhile, Facebook has about $10 billion in cash on its balance sheet but estimates of its employee stock compensation tax bill put the number due at between $2.5 to $4 billion, an amount Facebook had reportedly hoped to pay by doing a follow on public stock offering. While no law prevents them from still so accessing the capital markets common sense would dictate that investors may not be favorably inclined. Company executives and investors sold numerous shares in the IPO, leading to doubts as to their faith in long term company prospects.

A vast number of Facebook employees were hired over the past year or so at a higher stock value than exists today and thus their options are underwater, making their job less lucrative. Silicon Valley workers are a notoriously fickle bunch as other opportunities abound.

Facebook’s mobile strategy is still not established to most analysts’ buy-in, with users shifting quickly to accessing the site via cell phones and their much lower advertising revenues.

Friday many news services reported that Reed Hastings, a Facebook board member, had purchased about $1 million worth of shares Wednesday at an average price of $21.03 per share and the Harvard Endowment has also been buying. Fidelity, a long time holder (relative) has reportedly been dumping shares along with other funds. Numerous companies in the general sector have likewise plunged in value, Linkedin being an exception, and venture funding for younger companies has reportedly gotten resultantly tighter.

To run the IPO the company hired a respected firm, Morgan Stanley, and long-time technology banker Michael Grimes. Their board is seasoned and they’ve had their pick in hiring a solid management team. So what went so wrong and how bad is the situation really?

First, I don’t follow Facebook closely and have never owned a share of their stock. Having spent years as a technology and Internet investment banker however I keep finding my eyes drawn to the related stories. One always puzzles over such situations, hoping to not provide bad advice down the road.

One very troubling issue with respect to the plunge in Facebook’s stock price and related company confidence is that Facebook operates in a consumer market, which is heavily driven by perception, trends and reputation. Is Facebook not all that people thought? Is it no longer cool? Will growth sputter and users migrate elsewhere?

As a consumer I like Facebook. In my opinion they’ve changed how people communicate and have such a large established base of users switching to another site just seems like a pain. The interface is friendly enough and, while the frequent site changes get annoying, none are deal breakers for most users. Being on is easier than being off. But I’m only one person.

The deal issues abound.

Interesting is how off in valuation the private exchanges like Second Market were in valuing Facebook. The IPO price was near recent private market trades, which were made by larger institutional and accredited investors. That metric proved to be a poor one, which I find a little surprising. Theoretically, private companies are worth less than public ones due to the difference in liquidity. In this case, the increased liquidity of the private markets seemed to hype the price and the public markets settled it at a more reasonable valuation.

Pricing an IPO high isn’t always a killer; pricing this much too high is a problem. Bruce Wasserstein, known as “bid em up Bruce” for his ability to maximize valuation for his clients, was accused of over pricing Lazard’s stock in its IPO many years ago. The price plunged after trading began and Goldman Sachs, the lead underwriter, was said to take a big loss supporting the share price in the aftermarket. Called a “broken IPO” by Forbes in 2005 the stock ended its first trading day down about 4 percent, but after volatile trading and much underwriter intervention. According to GoogleFinance it’s now up 17 percent since the IPO, a marginal return. Lazard, by the way, is an ex-employer of mine and a very well respected firm, and Wasserstein was known as a deal genius. Lazard is also operating in an industry which has been getting crushed over the past few years. As in the Facebook IPO extra shares were added to the offering late in the IPO and insiders sold a solid slug of shares. Lazard has prospered; its investors not always.

Still, most people would likely agree that upping the size and price of the offering in a weak market was a mistake, at least for Facebook. Such vast sales by insiders were also troubling. Reporting weak results in the first earnings report after the IPO was also a judgment error. Typically, the timing of an IPO occurs when results are on an upswing unless you’re worried about long term results and want to raise cash while a window still exists. Bad advice or bad judgment?

Overall, from an investment banking perspective a lot went wrong, which will limit Facebook’s access to the equity markets for a while. Having said that, the company did succeed in raising a lot of cash and rewarded certain longtime investors and employees. I hope the management team is actively reaching out to large investors and industry analysts. Regarding journalists I feel mixed. The press coverage has been more negative than positive and was such heading into the IPO itself, a troubling issue. More bad stories won’t help so I’m not sure now is the time for broad press outreach (better when the share price has stabilized or when the company has something positive to report).

Facebook’s biggest problem is in perception, that perhaps there only is a little man behind the curtain. Financially and business wise the company is fine and by performing well can eventually recover credibility with investors. At almost $50 million in valuation the company story is still amazing and inspiring. But if users perceive the company such that they begin to use the site less and less then Facebook won’t recover. Now really is the time to keep heads down and deliver to their user base. The market is only one metric and does reward good companies over time. No one ever said being a public, or high profile, company is easy. Facebook gives us a great story and hopefully it continues to be more Horatio Alger than the alternative.

Megan Lisa Jones is an investment banker, lawyer and author who has advised high growth, innovative companies in various industries including technology, Internet, media, gaming and consumer retail. She recently began an online education venture that focuses on parents and students. You can follow her at www.meganlisajones.com.


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