Facebook Fixin' to Bite Bears
The stock is much cheaper than it was a month ago, and sentiment toward it has turned ugly, setting up a tradable rally.
Nearly four weeks ago, on the morning of Facebook's (FB) ill-fated public offering, I called the IPO "dangerously overpriced," and warned that the company lacked sufficient growth prospects to justify its "nosebleed valuation."
This was before the Nasdaq (^IXIC) bungled the initial order crush, saddling many eager buyers with lots more shares than they wanted. The stock hadn't yet dropped 15% from the day's highs to close barely above its offering price.
The shares would go on to slump 32% below that offering price over the next three weeks, rewriting the movie script from "Awkward Genius Conquers the World and Marries the Girl" to "Wall Street Destroys Mom and Pop, Part 97."
So here we are, and none of my long-term reservations have really changed. If anything, Facebook's struggles to monetize its vast user base via ads have received more skeptical scrutiny as its shares sank.
Its decelerating revenue growth and negative cash flow have been masticated into bearish gruel. New concerns about recent declines in the number of users playing games hosted by key Facebook partner Zynga (ZNGA) will only add to investors' apprehension.
The next earnings report, the one for which the underwriters of the IPO have already cut estimates as if on cue, is still nearly two months away, to be followed in August by lockup expiration that will boost the public float by two-thirds.
So why do I believe that the path of least resistance for the stock over the next month is higher, perhaps significantly so?
Start with the valuation: Facebook's market capitalization is down from $81 billion at the offering price, and $96 billion at that day's high, to a considerably more reasonable $59 billion as of Tuesday's close.
This values Facebook at 51 times this year's estimated earnings and 42 times next year's expected earnings-per-share. Not exactly cheap, but hardly nosebleed levels in the context of other Internet and social networking names. For example, LinkedIn (LNKD) is fetching 139 times this year's hoped-for earnings per share and 77 times next year's presumed haul, and that's with the stock down 20% since May 4.
LinkedIn is growing revenue more than twice as fast as Facebook, 100% vs. 45% year-over-year, but its sales are also more than six times smaller and can be reasonably expected to slow dramatically long before they approach Facebook's current ballpark.
And while LinkedIn's focus on professional networking and recruitment has been a boon to date, it also limits the franchise's mind-share and long-term potential. When was the last time someone you knew posted anything on LinkedIn besides an updated resume?
So, without getting bogged down in valuation metrics, let's just stipulate that social networks less famous and entrenched than Facebook now sell at a premium to Mark Zuckerberg's pride and joy. And say what you will about Facebook, its capacity to leverage its first-mover advantage into new profit opportunities is considerably greater than Yelp's (YELP) or Pandora's (P).
But the real reason to consider buying Facebook is not because it's the least overpriced mansion on the costliest block; after all, Apple's (AAPL) faster growth and huge incumbency advantages are still much cheaper. Nor does it have much to do with Facebook's treasure trove of highly personalized data, which might one day help it dethrone search king Google (GOOG) or perhaps invent the next big thing.
The real reason to believe the near-term trend from here is up has to do with how much of the bad news has been baked into the stock, the speed with which speculative fever has transformed into widespread disdain and the punishment already meted out to weak hands who sold in the last month at a loss.
Take UBS (UBS), which reportedly ended up with much more than the one million Facebook shares it sought by entering the order repeatedly during the IPO's botched launch, ended up losing as much $350 million by dumping some of those shares below $30. It's done selling. And so are thousands of small investors who expected to get richer quick and ended up dumping the stock when it failed to perform.
Also likely done selling for the moment are the short sellers who've already borrowed and sold 34 million shares-representing 8% of the current public float and a full day's worth of recent turnover, which has dried up notably. This is far more bearishness than is typically the case for large-cap stocks, as Bloomberg notes.
There is ample precedent for popular IPOs taking off after an awful first month. LinkedIn, which went public almost exactly a year before Facebook, doubled on its first day of trading but then dropped 32% over the next month before quickly recovering its mojo.
And 15 years and two days before Facebook's public debut Amazon.com (AMZN) went public with almost as much hype, only to fall below the offering price four days later. That old chart, courtesy of venture capitalist Bill Gurley, looks eerily like Facebook's recent stretch: Roughly a month of underwater skidding on sharply diminishing volume. In Amazon's case, the share price than soared 51% in just ten days.
This isn't 1997, of course. But that doesn't mean that Facebook can't turn back the clock on the many bears getting ready to bury it.
Editor's Note: This article was written by Igor Greenwald of MoneyShow.
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