Barron's Pushes Facebook (NASDAQ:FB) Under $21, So Where Do We Go From Here?

By Michael Comeau  SEP 24, 2012 3:10 PM

Barron's says Facebook is worth $15. Are they insane?


MINYANVILLE ORIGINAL The party's over for Facebook (NASDAQ:FB) -- at least according to Barron's.

This weekend, writer Andrew Bary declared Facebook to be worth $15 a share, throwing a freezing bucket of water on the bull camp that was reinvigorated by CEO Mark Zuckerberg's September 11 appearance at the TechCrunch Disrupt conference, at which he gave a sunny outlook on the company's mobile advertising business. (See: Wait a Minute! Did Facebook's Mark Zuckerberg Really Say Anything New?)

A purely anecdotal look at the Twit-O-Sphere indicates that some folks are rolling their eyes at the Barron's story, viewing it as a rehash of old news and thus a reason to jump into the stock.

Now, I've knocked Barron's many times in the past for what I viewed as incorrectly bearish articles on particular stocks. Nonetheless, they deserve props for correctly slamming the Facebook IPO back in May.

But we're many, many dollars away from Facebook's failed $38-per-share IPO.

Let's take a look at Barron's big bad bear case.

Here are the main points:

1. The stock is dramatically overvalued relative to Apple (Nasdaq:AAPL) and Google (Nasdaq:GOOG).
2. Wall Street's earnings estimates do not reflect stock-based compensation, which overstates profitability.
3. Due to heavy infrastructure spending, consensus 2015 estimates of about $1.05 per share may not be achievable.
4. Last week, research firm eMarketer cut its estimates of Facebook's revenue.
5. Mobile ads, including Sponsored Stories, may be screwing up the user experience.
6. The app model favors more specialized sites like Twitter, Pinterest, LinkedIn (Nasdaq:LNKD), Yelp (Nasdaq:YELP), and Trulia (Nasdaq:TRLA)
7. Lock-up expirations could weigh on the stock.

We can argue some details here and there. Are Apple and Google really appropriate points of comparison? And isn't it a little soon to worry about 2015 estimates? But these are all more or less valid points, even if they're pretty much all well-known among the investing public.

Facebook is an outrageously expensive stock -- but that's not necessarily the worst thing in the world. A high P/E is not inherently bad (see: Provides Lesson on Dangers of Shorting High-Octane Momentum Stocks) and a low P/E is not inherently good (see: RIM: A Low P/E Does Not a Cheap Stock Make).

And when is a high P/E OK? When a company is firing on all cylinders, generating huge revenue growth, and destroying expectations. Think Fusion-io (FIO), which beat earnings expectations by 125% last quarter.

So that brings us to Facebook.

Here's the problem.

Mark Zuckerberg messed up big-time by raising investor expectations regarding mobile advertising monetization at the aforementioned TechCrunch conference. He has to keep a positive public appearance for the sake of employee morale and recruiting, but as investors, our concern is simply, what's priced in and what's not?

Zuckerberg always talks about Facebook's long-term potential -- at the conference, he very specifically mentioned measuring the company's success over a three- to five-year time horizon.

And this is why I think investors have taken this sentence way out of context: "I actually think it's a great time for people to join, and it's a great time for people to stay and double down." Given the subsequent bounce in the stock, it seems that investors interpreted that statement as Zuckerberg guiding up for the quarter, which seems a little presumptuous given the fact that he's so long-term oriented.

Thus, Facebook may not be able to beat rising expectations.

That means extreme risk heading into the next earnings report. In fact, I posted this on Minyanville's Buzz & Banter (click here for a free two-week trial, on me) late Friday afternoon:

I'm having an awfully hard time resisting throwing money at Facebook because I see little downside risk until the next earnings report (which I am afraid of).

Mark Zuckerberg's appearance at the TechCrunch conference -- which I think didn't really offer anything new -- gave the bulls some much-needed confidence and the bears a reason to stop shorting/selling.

That definitely gives the bulls the near-term advantage.

However, I remain more worried than most about the quarter.

The Zuck said it was a great time to double down on Facebook, but he wasn't necessarily talking about the stock based upon some near-term financial acceleration. To me, he was talking about Facebook as a place to work.

One thing's for sure -- if Facebook doesn't have a huge, mobile-driven quarter, it's getting the smack down BIG TIME. In fact, when we do get to earnings season, I might buy way out-of-the-money puts to bet on this possibility, because sentiment just took a 180-degree turn based on questionable evidence.

I am still thinking of putting on a bet that Facebook crashes below $15 or even $10 by year-end.

Why? Because as I said on the Buzz Friday, sentiment took a 180-degree turn on very questionable evidence.

Of course, the Barron's story has injected negativity back into investor perception of Facebook, but that's not going to stop the stock from collapsing on a bad quarter.

I don't know for sure that Facebook's going to have a bad quarter -- I just know that it will be wrecked if it does, and thus betting on a disaster may make sense. I'm thinking moderate risk for extreme reward.

The particular options trade structure I'm considering is a modified risk-reversal, where I would sell call spreads to finance the purchase of put options (see: 9 Weeks to Better Options Trading: Risk Reversals). This strategy would give me significant exposure to a sharp downside move in Facebook, with defined risk should the stock rally.

Twitter: @MichaelComeau

Position in AAPL

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