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Thursday, May 24, 2012
The Facebook fizzle
The initial public offering (IPO) for Facebook, the social networking website, generated a media frenzy rarely seen since the dot.com bubble over a decade ago. Those who missed out on Friday's IPO could still buy shares through Tuesday, although the offering produced more press than profit — at least for anyone who was not among the company executives holding shares when sales began. After a short glitch on the Nasdaq, trading took off, but prices stayed constant as investors realized that no one knows what Facebook is worth — a fair question since no one really knows how it is going to make money.
Founded in 2004, Facebook was a Harvard University dorm-room project that captured the enthusiasm and potential of the social networking phenomenon. In less than a decade, the site has attracted more than 900 million users; if it was a country, the Facebook nation would be the third most populous in the world. It generated sales of $3.7 billion in 2011, and they are expected to hit $6.1 billion this year, a 64 percent increase.
But while membership continues to expand, experts are not sure how the company will turn that extraordinary size into money. Last month, Facebook said first-quarter profit dropped to $205 million as sales growth slowed and marketing costs more than doubled. Revenues look set to slow for the third straight year as advertising sales have not kept pace with the growing number of users.
Nonetheless, believing that where there are eyeballs there are profits, management decided to take the company public and enlisted a crack team of bankers to enrapture investors. They developed the traditional "roadshow" in which the bankers fanned out across the country to gin up interest in the company. They created a video and had company executives speak to stimulate potential buyers. And the bankers are paid for their trouble — 1.1 percent of the proceeds. (While that percentage is low, total remuneration is expected to reach about $176 million.)
But when the Friday morning market bell rang and shares went on sale, the results were disappointing. The volume of shares that changed hands was a high 567 million, more than the total number of shares issued. But prices did not move.
Many IPO purchasers hope that they can get in early and generate big profits on a quick turnaround as market enthusiasm ratchets up prices. But Facebook opened at $38 a share and closed at $38.23 — not a lot of quick profits there. In Tuesday trading, it hit a low of $31. That contrasts with an 18 percent price rise on Google's first day of trading in 2004 and a 49 percent leap for the professional networking company LinkedIn Corp. last year.
Still, 421.2 million shares were sold Monday and $16 billion was raised on Friday, making it the third-largest in U.S. history. The company now has a market value of $104.2 billion. That compares with Google, which was worth more than $200 billion at Friday's close, and Apple, the world's most valuable company with a market value of $496 billion.
There are several explanations for the lack of enthusiasm; two stand out. The first is the decision to price the offering at $38 a share, on the high end of the trading range announced last week, which was itself a jump from the initial range of $28 to $35. That decision was followed by the announcement that longtime investors such as Goldman Sachs would be selling large blocs of their own holdings. Both moves suggested that Wall Street insiders may have known something that ordinary investors did not.
The second problem is one that has haunted Internet-related stocks since they first hit the markets: No one is sure how to price them. It is not clear how Facebook will make money. It has members, it has users and it has potential, but there is as yet no clear strategy on how to "monetize the eyeballs." In particular, investors and analysts are not sure how Facebook will work as more users migrate to mobile platforms, rather than computers. The announcement last week that General Motors would end its advertising on Facebook increased nervousness about the company's strategy.
A share price of $38 was about 26 times per-share sales through March of this year. Or to use another metric, the price was 100 times earnings. Either way, as one investor explained, the executives and underwriters "squeezed the lemon dry here" — a sentiment no doubt encouraged by the decision of existing shareholders to sell their holdings.
One common criticism of such IPOs — that only well-connected insiders can profit — will be muted in this case. At the end of Friday, the stock's share price was supported by considerable repurchases by the underwriters. That means that ordinary investors have the chance to get in this week when those banks try to reduce their holdings.
Lucky them. Facebook may yet prove to be the investment of decade and the media platform that proves indispensable to 21st- century life. The troubles that dogged last week's IPO may prove fleeting; Apple too has had its ups and downs in the market.
Facebook executives need to better articulate their understanding of how they will make money for shareholders and not just themselves before investors push Wall Street's "like button" and hand over their money.