Facebook Inc may be having trouble connecting with Wall
Street.
The financial houses behind Silicon Valley's largest-ever
coming-out party kicked off formal coverage of the company today by
warning about an uncertain business model, margin pressures and a
difficult transition to mobile technology.
The reports, released by banks involved in the IPO after a
40-day quiet period expired, represent Wall Street's broadest
assessment of the first US company to debut with a market value of
more than $100 billion.
Morgan Stanley and other major brokerages that handled the
blockbuster IPO said it remained unclear how Facebook plans to make
money from a growing number of users logging on to the No. 1 social
network via smartphones and tablets.
That helped send its shares down 3%.
Of the 17 brokerages that handled the blockbuster IPO and kicked
off coverage of the social networking company on Wednesday, eight
recommended against buying into the shares. Two of Facebook's three
lead underwriters - Goldman Sachs and JP Morgan - were most
bullish, targeting Facebook shares at $45 and $42,
respectively.
Morgan Stanley, which has come under scrutiny for its role in
driving a $38 IPO price that now appears lofty to some, stuck to a
price target that matched its debut level and "overweight"
recommendation.
The average of target prices cited today was $37.64 - a tad
below Facebook's stock market debut price.
Facebook's IPO was to have been the culmination of years of
breakneck growth for a company that became a social and cultural
phenomenon.
Instead, it was marred by a series of trading glitches on its
debut, and the company and its underwriters subsequently faced
accusations of pumping up the price and inadequate disclosure.
Wednesday's panoply of neutral or equivalent ratings is notable
because Wall Street research analysts have a reputation for
favoring "buy" ratings, particularly in the high-profile Internet
industry where "buy" or equivalent recommendations far outnumber
"hold" or lower ratings.
The US Internet sector's 110 companies sport a collective 561
"buy" recommendations or better, versus 352 "hold" or "sell"
ratings or their equivalent, according to Thomson Reuters
StarMine.
"It says there are real questions out there about the strength
of this business model, the fundamental strength of this company,
together with its valuation," said Tim Ghriskey, a portfolio
manager at Solaris Asset Management.
"We're not buying right now, that's for sure."
How lofty?
Banks are required to keep their employees handling IPOs apart
from analysts recommending stocks in order to avoid conflicts of
interest.
In the IPO, banks sold their clients shares of eight-year-old
Facebook, started by Mark Zuckerberg in his Harvard dorm room, at a
price equivalent to a whopping 100 times 2011 net income per
share.
That compares with Apple Inc's current multiple of 20.6 and
Google Inc's 18.9.
"I respect that a Chinese wall exists, but I think it feeds into
the cynicism that Main Street has for Wall Street - that one side
of the business was telling them to buy at $38 and the other side
of the business now at $32 says we shouldn't buy it," said Steve
Birenberg, a portfolio manager at North Lake Capital in Winnetka,
Illinois.
Most analysts expect Facebook's large user base to help it
corner a substantial share of the Internet advertising market in
the long term.
But half of the ratings released on Wednesday were "hold" and
its equivalent or lower - despite the shares trading sharply down
from their $38 IPO price.
Eight slapped top ratings - "buy," "outperform" or "overweight"
- on the social networking company.
BMO Capital Markets' Daniel Salmon began his coverage with an
"underperform" recommendation and a $25 target, translating into a
nearly 25% slide from current levels.
"Slowing user growth is one of our primary concerns for
Facebook's current valuation," said Salmon, the only analyst giving
Facebook a negative rating on Wednesday. He estimated Facebook's
annual user growth would be 22% next year and 16% the year after,
much slower than expansion in the past.
The 33 banks that participated in the stock listing were
required by securities regulations to wait until 40 days after the
first day of trading on May 18 before publishing their views,
limiting the research on Facebook until now to a handful of
analysts.
Scott Devitt at lead underwriter Morgan Stanley, who told the
firm's major clients that he had cut his revenue estimates on
Facebook just days before the IPO, said he expects Facebook's
ability to turn its mobile features into profit to be a challenge
for the next several quarters to several years.
He expects revenue to climb 31% in 2012, down sharply from the
88% growth in 2011.
"No one is debating the potential opportunity in front of
Facebook," said Channing Smith, a portfolio manager at Capital
Advisors. "However, there is disagreement in the analyst community
on the trajectory of the earnings and revenue growth in the coming
years. The assumptions analysts are making are guesswork at this
point."
Topsy-turvy IPO
Analysts at JP Morgan set a price target of $45 for the stock,
suggesting a rise of 36% compared with its close of $33.10 on
Tuesday.
Facebook shares were down 3.1% at $32.07 this morning.
Goldman Sachs set a target price of $42, less aggressive than
Morgan Stanley's $38 target.
The company's stock offering, one of the most highly anticipated
in history, was marred by a series of technical glitches at the
Nasdaq exchange.
Facebook's decision to increase the size of the offering by 25%
just days ahead of the IPO, as well as concerns about decelerating
revenue, also weighed on the stock, which traded as low as $25.52
before regaining some ground to trade in a $31-$33 range in recent
days.
RBC said it expected Facebook's stock to hit $40. BofA Merrill
Lynch and Morgan Stanley pegged the shares at $38, while Citi and
Barclays opted for $35.
The rush of research comes ahead of Facebook's second-quarter
results, expected sometime in mid-to-late July.
With about 900 million users, Facebook has become one of the
Web's top destinations, challenging established players such as
Google Inc and Yahoo Inc.
Even so, revenue growth from ads and other services is slowing.
The company, which last year was more than doubling the amount of
money collected every quarter compared with a year earlier,
reported growth of 45% in the first three months of 2012, and
revenue declined from the preceding quarter.
General Motors Co' announcement a few days before the IPO that
it would stop advertising on Facebook has added to the concerns
about Facebook's ability to generate business from advertising.
Despite $4.8 billion in expected revenue in 2012, the average
amount of money that Facebook makes through each user is still
relatively low, said BofA Merrill Lynch, which expects new
advertising formats to accelerate revenue growth in the second half
of the year.
In recent weeks, Facebook has unveiled a string of enhancements
to its advertising service, allowing marketers to target ads to
users on the mobile version of Facebook and to show Facebook users
ads based on previous websites that they have visited.
"The company is in the midst of a mobile usage transition and we
are cautious on Facebook's revenue trends until new mobile ad
revenue models start driving the top line," the analysts at BofA
Merrill Lynch wrote.
Several analysts working for the underwriters, including Morgan
Stanley and Goldman Sachs, cut financial forecasts for Facebook
days before the IPO, after the company cautioned about revenue
growth due to a rapid shift of users to mobile devices, where
Facebook is less effective at generating revenue.
The analysts briefed some institutional clients about their
revised forecasts, sources have previously told Reuters, but retail
investors were left in the dark.
That revelation has resulted in lawsuits alleging the banks and
Facebook failed to fully disclose the company's weakened financial
outlook ahead of its IPO.
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