Facebook's Botched IPO And The Irrational Craze Over Social Media Stocks (FB, ZNGA, LNKD, GRPN)

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It has been almost three months since social networking giant Facebook Inc. (NASDAQ: FB) completed its much awaited IPO. Expectations ahead of the IPO were huge. FB’s IPO was probably the most awaited since another technology giant, Google Inc. (NASDAQ: GOOG) listed its shares. However, one of the biggest ever tech IPOs has turned out to be a huge disappointment.

What made Wall Street go gaga over Facebook?

Founded in 2004 by Mark Zuckerburg, Facebook has seen phenomenal growth. At the end of the second quarter of 2012, the company had 955 million users.

FB caught the attention of Wall Street in 2009, when it was valued at approximately $10 billion. But that was just the start. By December 2010, privately held Facebook was valued at $50 billion. All the while, Zuckerburg resisted calls for IPO. Zuckerburg even refused some buyout offers, even as Facebook accepted private investments from companies, mainly technology firms.

The search for alternatives

With FB founder and CEO, Zuckerburg not willing to go for an IPO, investors began to look for alternatives in the world of social media. A series of Internet and social media IPOs followed, reminding some veteran investors of the dotcom boom of the late 1990s.

Professional networking site LinkedIn Corp. (NYSE: LNKD), Daily deals site Groupon Inc. (NASDAQ: GRPN), social gaming site Zynga Inc. (NASDAQ: ZNGA), and Chinese social media company Renren Inc. (NYSE: RENN) listed their shares as social media and Internet stocks became the fad.

The valuation assigned to some of these companies, and privately held Facebook prompted some investors to compare it to the dotcom bubble. As usual, the response from Wall Street was: this time it is different.

Finally the much awaited IPO hits the market

Facebook finally decided to go public after resisting a listing for years. One of the main reasons was that FB had crossed the 500 shareholders mark.

In February 2012, FB filed its S1 document with the SEC. The buildup to the IPO was unprecedented.

The initial IPO price range was $28 to $35 per share. This was raised to $34 to $38 per share just a few days before the IPO amid huge demand from institutional and individual investors.

The huge demand prompted Facebook to sell 25% more shares than it originally planned. The announcement to sell more shares was made just two days before the IPO. FB’s much-awaited IPO was priced $38 per share, which implied a value of $104 billion for the company.

Facebook’s valuation at over $100 billion was way above Google’s, when it listed its shares a few years ago.

Facebook finally made its trading debut on May 18, 2012.


The Flop Show

Problems for Facebook began on the first day of trading itself. Listed on NASDAQ, FB shares were expected to start trading at 11 AM EST on May 18. But, trading was delayed due to some technical issues that prevented some orders from being executed.

Since then, it has been downhill for Facebook. Nearly three months after the IPO, the stock has fallen nearly 50% from its IPO price.

A number of lawsuits occurred since FB’s IPO after Reuters reported that the company’s lead underwriters Morgan Stanley, JP Morgan and Goldman Sachs lowered their earnings outlook for the company in the middle of the IPO roadshow.

The performance of other social media stocks has not been any different. RENN shares are down more than 75% since their IPO in May 2011. GRPN is down more than 72% since its IPO in November 2011. ZNGA, which relies heavily on Facebook for its revenue, has fallen more than 68% since its IPO in December 2011. The only exception has been LinkedIn, which is up nearly 13% since its May 2011 IPO.

Why Facebook Flopped?

  • Investors’ expectations ahead of the launch were too high, which resulted in an overvalued IPO.
  • Investors are also concerned about FB’s revenue growth. The company’s revenue and user growth have been slowing. The company is not generating enough revenue per user, which is a major concern.
  • FB’s recent earnings report, its first since going public, also disappointed investors. Although the company posted a 32% revenue growth, investors were expecting more. Also, the company did not provide any earnings and revenue guidance.
  • Another worry is the lifting of restrictions on the sale of shares by FB’s employees and early investors. The first lock-up period expires in a few days, freeing some 268 million shares. Another 1.3 billion shares will be available for sale by mid-November. This could drive the stock price down even further.

Is the Social Media Craze Over

Maybe. But, Facebook’s botched IPO and the drop in other social media stocks cannot be compared to the dotcom crash. Unlike the dotcom era companies, Facebook has plenty of cash on its balance sheet. Remember, despite falling nearly 50%, FB is still a $50 billion company, which is more than the market cap of giants like Hewlett-Packard (NYSE: HPQ). Although user growth has slowed down, FB still has nearly a billion users. How Facebook shares will perform in the future will depend on whether the company can increase its revenue per user.

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