Social Media

6 Reasons Why the Facebook IPO Fell Flat


Well, that was anticlimactic.

After all the hullabaloo about Facebook's IPO, this is how it ends, with a mere $0.23 jump in share price? That kind of movement is what happens after Procter & Gamble announces a more absorbent type of Pampers.

Yet it shouldn't be all that surprising that Facebook's opening day on the NASDAQ had all the excitement of a Matlock rerun. While no one knows exactly why Facebook landed with such a thud, there are a handful of good reasons that the company got poked by Wall Street. Among them:

1. It Was Priced Just Right

Call it the Goldilocks theory. This assumes that a lot of thought went into that $38 price, and the reason that the stock didn't double is that the esteemed underwriters at Morgan Stanley, J.P. Morgan Chase and Goldman Sachs did their job right and accurately priced the stock.

That, however, depends on what your definition of "accurately" is. James Brau, professor of finance at Brigham Young University, says that over the past 40 years of IPOs, the average first-day pop is 18%.

So, if Facebook was looking to perform along those lines, it should have priced its shares in the low 30s.

In addition, underwriters don't aim for a flat performance on the first day because of a practice called "leaving money on the table," which rewards institutional investors for getting on board. Though that looks like a kickback of sorts, Brau says there's no clear-cut reason why IPOs always factor leaving money on the table in.

"There are at least 50 different academic studies I know of that that have 35 different theories," Brau says.

One popular theory is that it's a way of rewarding such investors for honesty. The argument goes like this: During an IPO road show, the company and bankers are looking for an accurate read on what investors plan to spend.

If such investors didn't know that they would be rewarded for telling the truth, then they would intentionally low-ball the amount they intend to buy at. If an institutional investor thought that the stock should be worth $10, say, then they might say they'll spend $8 to enjoy the ride on the opening day.

2. It's NASDAQ's Fault

NASDAQ bungled Facebook's opening, not offering the stock until 11:30 am EST, 30 minutes later than planned. In addition, the stock exchange didn't finish filling orders for the stock for about two-and-a-half hours. Kevin Pleines, an equity market analyst with Birinyi Associates, says the resulting confusion didn't do Facebook's stock any favors.

"It threw it a bit of a curve," Pleines says. "It may have held it back a little bit."

3. Investors Are Wary of Social Media Stocks

The media may love the story of the scrappy twenty-something building a $100 billion company from his Harvard dorm, but investors have seen this movie before. Of the 19 social media IPOs of 2011, 82.4% were trading below their opening-day prices by year's end. Only three were above their opening price.

4. It's GM's Fault

General Motors landed a well-timed blow against Facebook on Tuesday, when reports surfaced that the company planned to pull all its advertising from Facebook because it wasn't working.

Though no other advertisers appear to have followed suit, the move didn't reassure investors who were already nervous about Facebook's first-quarter revenue slide and its admitted inability to transition its ad model to mobile.

5. It's Overvalued

Facebook's valuation of $100 billion-plus, like most valuations, is based on expectations of future performance. In Facebook's case, these expectations are wildly optimistic. After all, at its current valuation, Facebook is worth more than McDonald's.

The Golden Arches, with restaurants all over the globe, close-to 100% brand recognition and a proven business model, posted $27 billion in revenues last year and a $5.5 billion profit. Facebook made $1 billion on $3.7 billion in revenues.

Not surprisingly, 79% of investors in a recent Bloomberg poll thought that Facebook was overvalued. As Espen Robak, the president of Pluris Valuation Advisors, told The Atlantic, Facebook's valuation is plausible because of the company's tremendous reach.

But, as Robak told the publication, no one knows how Facebook will be able to monetize that reach.

"Think of it this way," said Robak. "Google has a pretty standard price-earnings ratio right now — around 15 to 20. That's where Facebook will ultimately have to get. They need vastly larger profit.

"How many more ads can they sell? Four times more in the next year? I don't think so. They have to get revenues from somewhere else."

Robak thinks that maybe — just maybe — Facebook will be able to tap into its user data to provide a new solution to advertisers.

6. Retail Investors Are Taking a Wait-And-See Attitude

If you're an average joe, you probably couldn't get your hands on a share of pre-IPO Facebook stock. So, the logical thing to do is wait until the hype dies down and then assess the stock. Pleines' research shows that waiting at least a month is a good idea.

According to Pleines' data, no matter how well the recent social media IPOs did on opening day, their stocks were still down — across the board — after the first month.

But it's not just a social media thing: We may not remember it well, but Google's stock languished for a month or more after its debut. "While Google did not trade lower in its first month of trading, it did trade back its original open price of $100," Pleines wrote in a recent note to clients. "But after that it never looked back, trading as high as $196 over the next three months."

In other words, the question of Facebook's true value wasn't answered on Friday. In all likelihood, we won't know for a few months at least.

What do you think Facebook is really worth? Let us know in the comments.

SEE ALSO: Facebook's IPO Roadshow: We Give You the Video Highlights

Image courtesy of iStockphoto, EdStock

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