In the months since Facebook (FB) made its unpromising debut on the Nasdaq Stock Market, investors collectively have rendered their verdict on the value of the company’s stock. As of late Friday, they decreed a share in the premier social networking company is worth $21 – well below the $38 a share that underwriters managed to obtain three months ago.
Could it be that the skepticism for Facebook’s prospects is as irrational as the exuberance leading up to the IPO last May?
Analyst Brian Wieser of Pivotal Research suggests it might be. Weiser isn’t exactly a Facebook cheerleader. He was the first analyst to come out with a rating on Facebook after its IPO – a “sell.” Now, however, Wieser is emerging as a Facebook bull. While a price of $38 for the shares was too much to pay in the IPO (he suggested a price of around $30 would have been closer to fair value), Wieser just raised his target for Facebook’s shares to $33. The reason? In a report released Friday, he says he received “confirmation from a range of sources that marketers would spend incremental amounts of money with Facebook because of its new exchange, its self-service mobile initiative and its prospective ad network.” The emergence of a “real-time bidding” model as an “increasingly important component of the online advertising ecosystem,” Wieser says, should help drive incremental sales for Facebook.
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We can’t comment on Wieser’s sources, obviously. But his baseline argument – that the market is irrational – is one that anyone who has spent more than a few hours pondering market trends clearly and logically would have to endorse. Please note: I’m not talking about the long term, here, or even about what happens to a “seasoned” stock of a blue-chip company. I’m referring to the kind of irrationality that surrounds a stock that is new to the market, whose fundamentals are in flux, that is part of an entirely new wave of businesses and one to which investors attach particularly high expectations.
On any given day, in response to the slightest piece of news (or rumor), investors will inevitably overreact on both the upside and the downside. That’s what lay behind the furor that preceded Facebook’s IPO, and the same kind of irrational responses are the reason that Facebook’s stock has slumped so dramatically. When investors are looking for a reason to despise and shun a formerly high-expectations stock like Facebook, they’ll find one. And when they’re not, they’ll put blinkers on to avoid pondering the downside implications of news from the company, as often seems to be the case with Amazon (AMZN).
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As far as Facebook is concerned, Wieser writes, “it is almost as if investors collectively went to see the U.S. Men’s Basketball team play at the London Olympics only to come away disappointed that they did not win the gold [medal] in swimming.” Pricing for perfection is irrational; so, too, he argues, is refusing to recognize that the negatives that hover over the company are exaggerated. These include questions surrounding Zynga (ZNGA) and the company’s ability to get users of its mobile app to click on ads.
The one real concern that Wieser has about Facebook is the share overhang. As is the case in any IPO, insiders face a “lockup” of their stock holdings for a prolonged period of time following the deal’s completion – almost always for six months. The intent is to make sure that an influx of new shares doesn’t flood the market while a newly public company’s stock price is trying to find the right level in the weeks following the IPO. Once a stock is “seasoned,” it’s easier for the market to absorb an influx of new supply without nerves being too rattled.
But as with any kind of rule of this nature, there are unintended consequences. Knowing that six months after the IPO, insiders finally will be free to sell creates what has become known as an “overhang” that weighs increasingly on a stock’s price as that deadline approaches. The more shares available to be sold, the greater that overhang.
There are about 1.1 billion shares of Facebook now in the hands of current and former employees and other insiders that could be sold when the lockup expires in a few months’ time. That’s a large enough quantity to be worrying, but, as Wieser points out, the decline in the stock price likely means that even if some of those insiders were eager to sell out completely – to buy a house, a yacht or just diversify their portfolios – many may well decide to hold off until the prices are higher. So, ironically, the slump in the share price that has taken place in the last two and a half months may play help prevent a more dramatic and sudden one in November. “Certainly, some money (will) be taken off the table,” argues Wieser. “But far from all of it, given what we believe to be a widespread view among the technology community that the Facebook platform is real and durable.”
The platform may be real and durable, but what remains too unclear for the comfort of many investors is whether it can also be a lucrative one for Facebook and its shareholders. Especially after the turbulence of the last few months, they are likely to want more in the way of proof and fewer upbeat comments about possibilities and probabilities form either Facebook insiders or even independent analysts like Wieser.
This isn’t the kind of market environment in which investors are eager to take big risks – especially after getting burned by buying Facebook at $35, $38, $40 – or even $42 – a share. On the other hand, should evidence begin to materialize that Facebook’s ad efforts are paying off, stand back and wait for an entirely different kind of irrationality to seize hold of Facebook. Odds are, whatever the fair value of the stock may be, its price is likely to swing wildly to either side of it for months to come.
