Seeing the Future of Facebook’s Stock
by Adrienne Edwards | University of Pennsylvania
Friday, May 18, 2012 was D-Day for one of the most famous companies currently in existence: Facebook. Friday was the day talked about for years among those studying the company and its business model — it was the day Facebook went public.
The trading started 30 minutes late, but the first share finally traded at 11:30 AM. The price immediately jumped from its opening price of $38 to $42. Yet, by the end of the day, the stock closed just above $38 at $38.37, after trading most of the day around $40 and $41. The closing price meant that most of the investors that had bought Facebook on Friday had lost money by the end of the day.
Yet, considering the hype and discussion around the event, Facebook’s first day on the market was a flop. What does that mean for the company and 900 million people that use the site?
Frankly, it could mean nothing. Many companies have had lower than expected beginnings when brought to market. For example, Google executives hoped to have a starting price between $108-$135 a share, but went on to have Google stock trade around $100 on its first day. Today, Google stock is about $600 a share, which is 700 percent of its $85 offering price. Other companies, such as Groupon, have faced similar valuation concerns and still continue to be well-traded stocks. Plus, other social media stocks such as LinkedIn have done well on the market, so there is some precedent for success in the field.
However, this could also be the beginning of the Facebook bubble bursting. There were many risks with Facebook stock, as many market watchers reported shortly before the IPO. For one, Facebook admittedly had unsustainable growth (about a 50 percent increase in daily active users over one year). Investors don’t know what to expect growth-wise from the company and subsequently, are uncertain about its future earnings that will affect the stock price. What happens when that growth slows or stops?
Furthermore, Facebook is based on the very fragile concept of collecting voluntarily publicized information that allows for targeted marketing. If Facebook suddenly becomes repulsive to a third of its users, or the government cracks down on how it collects information, or it is suddenly deemed extremely hazardous to the psyche, then the company could lose a lot of value, almost overnight.
However, the main risk is Facebook’s possible overvaluation. Facebook has a price/earnings ratio of around 90-100X, meaning that Facebook is worth 90-100 times its actual earnings. Compared to Google’s 18.2X, this valuation is excessive. (Compared to LinkedIn’s 600X, this is paltry, but some would argue slightly undervalued is better than slightly overvalued for investors.)
While overly optimistic valuations are not rare, Facebook’s may be different because of the way in which the company generates revenue. Eighty percent of Facebook’s revenue is based on advertisements that many users probably don’t actually use. I could be in a unique circle of friends and acquaintances, but I don’t know many people that buy products based on an advertisement they saw on Facebook.
News broke prior to the IPO that General Motors pulled its advertisements from Facebook because they deemed them “ineffective.” (Side note: GM also pulled its ads from the Super Bowl, suggesting it may be making an entire marketing overhaul. This may not foreshadow a similar trend of pulling advertisements from Facebook in other companies.) I have never heard of anyone making a purchase based on a Facebook ad, especially not in comparison to magazine, television or even other better placed online advertisements.
And, as many others have said, Facebook Mobile doesn’t and can’t have advertisements, and many users may resort to using only that version of the site. If advertisements aren’t reaching their intended recipients, companies could pull them and Facebook’s revenue and earnings would decrease.
A Facebook bubble burst on the market, however, would not signal the end of Facebook as much as the reverse — people will leave Facebook, and then its stock would suffer. No matter if companies start pulling ads or if the stock continues to trade lower than expected, Zuckerberg and his team will find a way to make profitable use of the 900 million users’ information. The real downfall of Facebook will come when fewer people use it.
Unfortunately, Facebook may have passed its prime; an older generation is beginning to use it, scaring their horrified younger relatives away, and more than ever, members of the younger generation may start deeming it “lame.” This trend will most likely not reverse. Facebook will end when people drift off to other sites and stop sending Facebook traffic, which will hurt its earnings and then its stock price. So no matter how much this IPO flops, Facebook’s success will not primarily depend on how the stock does on the market.
Yet, as I write this, I’m logged into Facebook right now, along with several other of my Facebook friends. A scenario where people stop using Facebook is unlikely to occur in the near future. Nevertheless, it’s important to watch where the stock moves from here as a foreshadowing of how much Facebook as a company is worth to others. Only time will tell.Adrienne Edwards is a voices contributor for Next Gen Journal. She is currently studying Philosophy, Politics, and Economics at the University of Pennsylvania.