Facebook (FB) has seen a tsunami of selling by insiders since May 17 when its IPO raised $16 billion for insiders, early investors, and the firm. Its share price nosedived from $38 to $19.52, around half its IPO price, as of close of business on October 15. There will be even stronger downward price pressures on the stock before year-end.
Investors who bought when Facebook was still private sold enough shares at the IPO to make many multiples of their original investments: Goldman Sachs, Greylock Partners, and Microsoft combined sold 38.5 million shares for more than $1.4 billion. Peter Theil invested $500 thousand in Facebook; since the IPO he’s sold all but 5.6 million of his original 44 million in stages to cash out around $1 billion.
That’s just so far. It looks as if there’s an even larger tsunami of selling coming before year-end as lock-ups expire on restricted shares. Most belong to Facebook’s employees, and Facebook will have to sell shares to cover employees’ tax bills. CEO Mark Zuckerberg sold $1 billion worth of his shares at the IPO to cover his own tax bill.
Facebook’s IPO was 421 million shares. In August, the lock-up for 270 million shares expired (60% additional shares), and Facebook fell 7% to hit what was then an all-time low of $19.88 per share. But the worst is yet to come. Before year-end, the lock-up for more than 1.5 billion shares expires. Look out below.
Few new buyers will likely step in at the current price given the previous wave of insider selling, several resignations of top Facebook officers, security holes, potential double counting of mobile users who also access Facebook from computers, potentially inflated user counts due to phony profiles and imposters, pressure on Facebook’s margins and profitability, questions about its strategy, serious failures to protect users’ privacy, advertiser complaints of bots clicking on ads and inflating their costs, Facebook’s sudden changing of algorithms to the detriment of advertisers, multiple lawsuits, and price to earnings multiples that are extremely high versus other technology stocks and other stocks in the S&P.
Facebook Price at 15 Times Earnings: Less than $5
Proven companies are often considered a buy at 12 times earnings and a sell at 15 to 20 times earnings. In that context, Facebook’s IPO value at 107 times trailing 12-month earnings was laughable. Apple trades at around 14-15 times earnings. If Facebook traded in the low single digits, say below $5 per share, it would be more in line with a reasonable price to earnings multiple. Its prospects and performance so far don’t merit a high multiple.
Key Issue: Mark Zuckerberg’s Controlling Shares
Mark Zuckerberg retains an estimated 22% ownership share in Facebook and owns 57% of the voting shares (there’s a tiered stock structure); that’s likely to be an ongoing negative for both users and advertisers.
Zuckerberg’s IM: People Who Trust Him Are “Dumb F**ks”
The New Yorker profiled Mark Zuckerberg and included IM’s from Zuckerberg’s college days:
Zuck: Yeah so if you ever need info about anyone at Harvard
Zuck: Just ask.
Zuck: I have over 4,000 emails, pictures, addresses, SNS
[Redacted Friend’s Name]: What? How’d you manage that one?
Zuck: People just submitted it.
Zuck: I don’t know why.
Zuck: They “trust me”
Zuck: Dumb fucks.
Zuckerberg admitted to the New Yorker that he wrote the IM’s and says he regrets writing them. The article mentions there are even more equally embarrassing IMs.
I can well imagine Zuckerberg regrets that this is now public information, but the problem is he doesn’t seem to have grown out of the underlying behavior. In fact, there’s a pattern of problems at Facebook that suggests to me the philosophy represented by his earlier IMs is entrenched in Facebook’s culture.
Many People “Do Not Trust Facebook” Anymore
In July 2011, Christopher Soghoian, a privacy advocate at the Center for Applied Cybersecurity Research at Indiana University, told the Wall Street Journal: “People do not like Facebook. They do not trust Facebook. Facebook gets people to give up information under the claim that it’s private and then it’s made public. And your only option is to shut down your account.”
New Tsunami of Insider Stock Selling is Likely
Just as some insiders bailed out at the IPO, new insiders who can sell for the first time are likely to bail out as soon as their lock-ups expire. If you were unlucky enough to buy shares in Facebook’s IPO, do you want to hold on in the face of potential heavy selling? Here’s the past and upcoming pre-year-end schedule of shares available for sale:
May 17, 2012 IPO: 421 million shares
August 16, 2012: 270 million shares
Oct. 15 – Nov 13, 2012: 243 million shares
Nov 14, 2012: 1.2 billion shares
Dec 14, 2012 149 million shares
Just because shares are available for sale doesn’t mean they will be sold, but it’s likely that freshly unlocked insiders will want to take the money and run. Here’s why.
The Plummet So Far: Revenue and Profit Squeezes
Facebook’s over-hyped May 2012 IPO was priced at $38; it opened for public trading at $42.05 and closed that day at $38.23. As of the close of business October 15, 2012, Facebook traded at just $19.52, and it’s likely to continue its nosedive.
At the time of the IPO, Facebook had $3.7 B in annual revenues of which 85 percent came from advertising, and it had only $1 billion in net income.
Even worse, its revenues were decelerating. Facebook depended on ZYNGA Inc., maker of five of its most popular games, for around 12% of 2011 revenues. ZYNGA’s earnings have been in trouble and its own stock has plummeted. It raised $1 billion when its IPO came to market at $10 in December 2011. Its price was only $2.42 at the October 15 close. In less than a year, its share price has tanked more than 75%.
Facebook changed its algorithms which contributed to ZYNGA’s revenue slide, and ZYNGA in turn may lure Facebook users–along with their revenue–to other platforms.
Another key issue is that it’s unclear whether Facebook can make money from its fast-growing mobile users, an increasing percentage of its user base. Mobile users will see fewer ads on the smaller screens. Facebook estimates that around 600 million of its so-called one billion users (there’s likely double counting of some mobile users who also access from computers) are from mobile devices, a 41% increase from last year.
Facebook announced its second quarter earnings on July 26, 2012 after the close of trading. Its share price fell 8.5 percent to $26.84 before the market close in the wake of Zynga’s dismal second quarter report. Facebook’s own report raised questions, and shares fell 10.7 percent to 23.97 in after-hours trading. Facebook’s sales increased to $1.18 billion, but it earned only 12 cents per share (adjusted) for the second quarter of 2012. Facebook had a fourfold increase in marketing costs and its operating margin declined to 43 percent from 53 percent last year. It also took a one-time charge for stock-award accounting to post a loss for the quarter of $157 million for an unadjusted loss of 8 cents per share.
Third Quarter Revenues and Profit Pressures: Expected report date October 23
Facebook is expected to report around 11 cents per share, down from 12 cents per share in second quarter. Particular attention should be paid to advertising revenues, the sources of these revenues, and the sustainability of these revenues. ZYNGA was 12% of 2011 revenues; an algorithm change hurt, and revenues from ZYGNA should be down. In future, advertisers may ask for steep discounts to combat the risk of sudden changes at Facebook.
Revenues don’t indicate corporate health if the company is losing profitability and cannot figure out how to reverse it.
Facebook Mantra: “We believe the lawsuit is without merit and will defend ourselves vigorously.”
Facebook faces lawsuits from unhappy IPO investors and from burned users. The merits of these cases and the potential liability are still being assessed. Look for more disclosure on this topic in Facebook’s next filing.
Facebook is the subject of an ongoing SEC investigation regarding whether Facebook made appropriate disclosures of material information for its IPO. Linda Sandler, Brian Womack and Douglas MacMillan at Bloomberg News wrote an epic piece on how Facebook operated during its IPO. The article, “Facebook Fought SEC to Keep Mobile Risks Hidden Before IPO,” (October 10, 2012) should be required reading for all Facebook investors.
Facebook is still seeking dismissal of the $15 billion lawsuit related to its secret tracking of users’ Internet activity after they logged off. Facebook argues users can’t prove damages, and this is being countered by citing the U.S. Wiretap act that allows up to $100 per violation per day per Facebook user.
In a separate case, a judge is questioning a settlement for “sponsored stories.” Around 100 million users weren’t aware that hitting a “like” button meant that Facebook used it as a commercial endorsement. It seems Facebook’s user “agreement” allows it to use photos, names, and personal information in advertisers” sponsored stories, and users still can’t opt out.
Post IPO Exodus of Top Talent
Joe Lockhart, former press secretary for Bill Clinton and head of Facebook’s global communications, announced his pending departure at the beginning of October, just 15 months after joining Facebook.
Since the IPO, Facebook also lost Ethan Beard and Katie Mitic, respectively the directors of platform partnerships and platform marketing, Jonathan Matus, the mobile platform marketing manager, Bret Taylor, chief technology officer, and Carl Sjogreen, Open Graph product manager.
One Billion So-Called Users: How Many Fakes and How Many Just Won’t Pay?
On July 14, 2011, I wrote that an imposter had created a profile of “me” on Facebook, and someone had also impersonated Warren Buffett. Why should advertisers pay for inflated “user” numbers?
Facebook claims over one billion active users, but it doesn’t know which users are real, which are duplicates or triplicates (or more), and which are imposters, which are someone’s pet dog, or whether it is double counting mobile users for revenue estimates. Advertisers deserve better metrics.
Facebook is still banned in China, so hoped for expansion into that market may not materialize.
More important than that, Facebook doesn’t know which users will generate revenues and which will just continue to be a maintenance cash drain. Facebook is having problems monetizing the new users it is bringing on board in emerging markets.
Did Facebook Deliberately Inflate Users at its IPO?
Given that people like me alerted Facebook to the fact that profiles were posted by imposters, how is it that Facebook didn’t qualify its user numbers at its IPO on May 17? In August, Facebook’s quarterly filing said that around 83 million of its then claim of 955 million members could be fake or duplicate accounts. That’s according to Facebook.
But why didn’t Facebook disclose this at the time of its IPO? It had fair warning.
Beyond that, Facebook doesn’t know if a user is impersonating someone else, meaning it can’t tell it’s a fake unless the person whose identity is being stolen–as mine was–is willing to jump through Facebook’s annoying hoops to correct the problem.
Revenue and Profit/Loss per User
Facebook apparently doesn’t have data on revenue per user. Facebook said it would rather report “overall growth in users” and “overall revenue” according to BloombergBusinessweek‘s previously mentioned article.
Tech bubble era companies also preferred to report overall users and overall revenue, and that nonsense contributed to their implosions. Facebook should be laughed off the financial stage for those “preferences,” and no prudent investor should put up with this rubbish.
Revenue from Facebook’s payments business is declining, and revenue per user is down in Asia. It will be interesting to see what Facebook has to say about this for third quarter after you strip away any potential window-dressing.
“Smishing” Friendly: Facebook Openly Listed Your Mobile Number on Its Mobile Version
Suriya Prakash, a security researcher, discovered that a user’s mobile number could easily be accessed by scam artists on Facebook’s mobile version. Facebook called it a “feature” not a flaw. If so, it was an unacceptable feature.
Prakash found that Facebook’s default privacy setting allowed “everyone” to find a user using the email or mobile phone number the user provided.
Facebook only blocked this on October 8, after Prakash contacted Facebook about the flaw. But who knows how many numbers and names have already been mined?
AARP’s October 2012 article, “Spam in Your Hand,” reported that at least 70% of cellphone text spam is an attempt to defaud you. Here’s a bonus. You’ll pay around 20 cents for each one of these fraud attempts you receive if you don’t have a text message plan.
It’s much worse if you respond. You’ll probably be directed to a site that installs malware to steal all the personal data stored on your cell. Alternately, you may be asked to dial a phone number, and your personal information will be solicited. This type of cell phone phising is called “smishing.”
Facebook Accused of Being Lax on Child Porn
According to Kate Drury of The Watchers in Australia, a new meme underage users were encouraged to post nude pictures of themselves on Facebook, and she has accused Facebook of allowing this to go unchecked. Apparently there are multiple pages allowing creation and dissemination of child porn on Facebook.
She reported Facebook to Crime Stoppers, the Australian Federal Police and other authorities. An investigation has been launched. Facebook did not respond to her emails according to an August 20, 2012 article in Technolgy.
Your “Private” Messages Aren’t Private
Facebook admitted it scanned so-called private messages. The Next Web reported that Facebook claimed it found a bug with social plugins on off-site pages, and it was attempting to fix the bug.
“Free” and Always Will Be, If You Pay a Heavy Price
If all of the above isn’t enough to persuade users that what they think is “free” is costing them way too much in terms of their personal privacy, Facebook now proposes to charge users $7 per post to optionally promote their personal posts
Facebook Efficacy in Doubt: Advertiser Claimed Bot Clicks Drove Up Costs
Limited Run in Long Island claimed it discovered evidence that bots clicked on its ads driving up its cost of advertising on Facebook. To be clear, Limited Run was not blaming Facebook for this, and Facebook claims it can’t corroborate Limited Run’s claim. But Limited Run maintains someone–perhaps a third party–was responsible. It built a page logger and provided Facebook with its evidence. It claimed 80% of the clicks it paid Facebook for were from bots. Limited Run has since deleted its Facebook page.
The source of the bots doesn’t matter if advertisers feel they are paying too much, if bots–not potential customers–are clicking on Facebook ads. For all Limited Run knew, it could have been a sabateur trying to discredit Facebook. But Limited Run made a compelling argument that got a lot of play on the web, and advertisers are taking note of that.
Facebooks Faces Stiff Competition for Advertising Dollars
Twitter, Linked-in, Facebook, and other social media sites all compete for advertising. Facebook’s arbitrary change of algorithm was a body blow to Zynga. The Financial Times reported that Facebook’s frequent changes have advertisers worried.
As noted previously, Facebook doesn’t provide key metrics like revenue per user. This puts its efficacy in question. GM famously pulled its advertising before Facebook’s IPO saying the $10 million it didn’t get results. But GM still buys ads on Twitter.
Facebook’s Competition Is Improving
Facebook got in early, but that doesn’t mean it will thrive as a company. Users have been annoyed by all of the above problems. Many users also complain that Facebook’s interface and display is old and tired looking.
Google+ claimed 170 million users in April 2012 (Facebook claimed 850 million at the time), and it has a fresher look than Facebook. But it’s users aren’t nearly as engaged, at least as of now.
Users are fickle, and young users will gravitate to the next exciting new thing. The rapid success of Catherine Cook’s myyearbook.com is an example, and she’s far from alone.
Investors may wonder when the next bright young kid will eat Facebook’s lunch and make it look like a site for old fogies. Facebook may adapt, and it can use its inflated share price to make acquisitions. But so far, it’s left a lot of room for doubt about its future.
Facing Reality
Taken as a whole, Facebook appeared unprepared to launch, and its IPO was wildly overvalued. The question investors should ask themselves now is whether they should bail out, as many insiders and early investors did, when Facebook first went public, because there’s a larger wave of potential selling before year-end.
Disclosure: I’m long puts on Facebook.
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