A Load o FB ull...

gretavo's picture

Not exactly 9/11 related, at least not obviously so, but given that I quit Facebook the day they took the company public in their now infamous IPO, I need a new outlet for more conventional rants. The first time I ranted about an IPO was when Google went public in 2004. My problem with the Google IPO in a nutshell is that while the company's assets minus liabilities at the time indicated a real value of about $3 (three dollars) per share, the IPO offered the shares to the public for between $85 and $100 dollars. By the magic of the stock market, the fact that the small fraction of existing shares that were available for purchase were sold at those prices meant that the rest of the shares were also deemed by "the market" to be worth that much, making the owners of all those $3 shares very happy (and wealthy) indeed. Neat, huh?

If that little gimmick weren't bad enough, it needs to be pointed out that neither Google nor Facebook are exactly "your grandfather's stock". See, grandpa used to buy a stock because it entitled him to a share of the profits the company made. If he owned $100 of Ye Olde Tyme Widgets, Inc., he might get a check from the company every year for, say, $10--his share of the company's net profits for that year. If his only other alternative was to keep his money in a bank account paying 5% interest, then he'd be pretty happy. Of course if YOTW had a bad year and lost money, he would get no dividend check, and the value of his shares might drop to $95 as fewer people wanted to own YOTW. On the other hand if YOTW was a well run company in a growth industry, those who owned shares could expect a steady stream of revenue from their shares. The more established the company and the more reliable its profits, the more people would want to own it. Given that there would always be a finite supply of shares, people might bid up the price of YOTW to $200. If the company made the same profit, $10 per share, then YOTW would only pay 5% of your original investment. After all, the less risk involved, the less reward, which is why bank accounts can be attractive even when they only pay 5% interest a year.

At some point some companies (like Google and Facebook) decided that they wouldn't share any of their profits with their shareholders, i.e. they would not pay dividends. People would have no reason to buy the stock except in the hope that someone would buy it from them later for more than they paid. Not being a financial wizard myself, I can't quite see the point, but apparently they were right. Google's stock, for instance, defied my expectations by rising to around $700 in just a few years (before dropping to below $300 and rising again to around $600 where it hovers today.) And all this while the supply of shares has increased, not decreased, as insiders have sold to the public the shares that they owned at the time of the IPO but which were not then available for purchase.

When Facebook's stock was offered to the public at $38, the book value, or assets minus liabilities, was around $2.50 per share. When the stock dropped in the first week to the mid $20s, much was made by financial pundits about the ridiculous price of $38. They complained that Facebook's earnings (that you're not going to get a part of anyway) didn't justify the resulting valuation of the company at $100 billion. Granted, when Facebook sold all those shares, they raised cash, which gets added to their balance sheet. So the book value did go up, but not to much more than $4 (four dollars) per share. In other words, even at its low of about $25, you would be paying a premium of $21 over what the company is actually worth, not for the right to a share in the profits, but for the right to sell that share to someone in the future. In the future may be this November, when Facebook insiders will be allowed to begin selling their shares, which of course were not available for sale when the lack of demand for FB caused the price to drop by 30%.

Obviously something fishy must have to happen--and probably will--for FB to do what Google did and seemingly defy the law of supply and demand. What will happen is that the pundits, analysts, and other assorted hucksters will change their tune about those earnings FB isn't going to share with you. As it happens, FB has been rallying in the last few days, back up to over $30. This is, we're told, because FB may actually earn more than everyone thought they could. But remember, whether they earn more means nothing to owners of the stock so long as the company isn't paying dividends. It's as if the 2012 set of Topps Yankees baseball cards became more or less valuable based on how well the Yankees were playing or were expected to play, even though owning the baseball card entitled you to nothing more than selling it to someone else. And even though the Topps company plans to print millions more of those cards to sell. We all know that's not what happens with an unproductive asset like a 2012 baseball card that unlike Honus Wagner cards are not in the least bit scarce! The difference? See below.

Is the WORST Over for Facebook Shares?

By Aabha Rathee

June 19 2012

On Monday, Facebook (NASDAQ:FB) shares gained 4.7 percent, or $1.40, to end the day at $31.41. That’s still down 17 percent from its IPO price of $38, but the social network has now seen its third consecutive day of gains and shares have now climbed 21 percent since closing at $25.87 on June 5. Those lows came largely on investor worries about the company’s ability to keep increasing revenue and make money from its growing mobile audience.

However, the company has now recovered more than $10 billion of the $35 billion in market capitalization it lost following its IPO. Even its lowest point of $25.52 from less than two weeks ago now appears to be a distant memory.

What is the reason for the sudden recent rise? Facebook has been spending a lot lately, but most of it has been on acquisitions that are expected to eventually help the company get rid of its technical rough edges. On Monday, it acquired Face.com, a facial recognition software maker whose technology the social network has used for a while. It also launched Facebook Exchange, a platform for real-time ad bidding, last week, prompting R.W. Baird analyst Colin Sebastian to write a positive review of the social network to investors. Sebastian reiterated an Outperform rating on the company’s shares and his $37 price target, saying that “there are signals the company is developing a third-party ad network” that may help in monetizing mobile usage much better.

Wedbush analyst Michael Pachter told MarketWatch that the launch of Facebook Exchange showed “that they are trying.”

“The important thing is that they are mixing it up, trying to find ways to better monetize, and I think that is important,” he wrote. “I don’t think any of us can know whether allowing access to browser history really makes advertising more effective, but Google (NASDAQ:GOOG) does it and people just love them,” he added. “It makes sense that this will work for Facebook, and I think that the market is finally seeing signs that Facebook management cares about growing revenue.”