It’s ironic that last week when I wrote the initial draft for this series, I could barely come up with 10 reasons why an investor shouldn’t buy Facebook (FB). That was before Facebook’s IPO on May 18th. In light of all that is happened since then, it is hard to understand why anyone would want to buy Facebook at this point. There has been an indication of earnings being lower than reported, an overvalued stock price, and a myriad of law suits against Facebook and its underwriters within the first two days of trading. Even more surprising is that investors didn’t sell their shares last week in light of such news. Facebook shares closed Friday at $31.91 per share, down
-16% from the $38 IPO price.
The Honeymoon for Facebook is Over
Things are not looking good for Facebook or for its main underwriter Morgan Stanley. It also looks like the honeymoon plans for Facebook CEO and recent newlywed Mark Zuckerberg, will soon be over as well. On the third day of trading, the main underwriter Morgan Stanley, the subsidiary underwriters, and Mark Zuckerberg of Facebook have already had several class action lawsuits filed against them from investors. You can view the press releases for Facebook on the Globe and Mail site, to see the firms that have already filed suit, and many more are likely to follow. The U.S. Senate Banking Committee has also expressed interest in the Facebook IPO.
The lawsuits aren’t just about the fact that retail investors lost money, which they did, rather the potential for known information which was not disclosed to all investors in a proper manner. Since 420 million shares were issued at a $38 IPO price, there are billions of dollars which were lost to retail investors, primarily within the first day of trading.
As the Glancy Binkow & Goldberg lawsuit points out, “the complaints allege that Facebook, certain of the Company’s executive officers and directors and the underwriters of the IPO failed to disclose… and cut their earnings forecasts and that news of the estimate cut was passed on only to a handful of large investor clients, and not to the public.” Many investors who purchased shares from Friday to Tuesday were not aware of the alleged reports of lower earnings by analysts, being different from the reported earnings in the IPO prospectus. If substantiated, it implies that retail investors were not privy to the same information as a handful of other investors, and that revenue was misrepresented.
However, as a recent Globe and Mail article points out, pertaining to disclosure of the Facebook IPO “… it’s perfectly legal for a securities firm to disclose analyst research to only some classes of clients and not to others -so long as the research process is untainted by interference from the investment bankers involved in the underwriting .” Regardless, whether it may be legal practice or not, or even ethical, full disclosure to all investors and the process of disclosure appears to be in question.
The Top 10 Reasons (continued…)
Here are the Top 10 Reasons why you shouldn’t even consider buying Facebook, continued:
7. Costs from legal proceedings of the IPO
Regardless of the outcome, as an investor in Facebook you are picking up the tab for all the current legal fees surrounding these allegations and lawsuits around the Facebook IPO. Many of these lawsuits could drag on for months if not years, with mounting costs. More importantly, if Facebook should be found guilty or agrees to a settlement, billions of dollars will have to be paid back to investors. That money will come out of any profits on top of all the ongoing legal fees.
8. Accountability and privacy issues
Putting aside the recent legal issues surrounding the Facebook IPO, there are other legal issues that could potentially surface for Facebook in the months to follow. Facebook has a sketchy past with privacy policies.
Zuckerberg’s first prototype for Facebook was called Facemash which he launched in October 2003 while at Harvard. To populate the content for the site, Zuckerberg hacked into Harvard’s security network and copied the student ID images used by dormitories and used them to populate Facemash, according to wikipedia. The site was shut down a few days later by the Harvard administration, who also laid charges against Zuckerberg for violating security, copyrights, and individual privacy. The charges were later dropped, but shortly thereafter in January 2004, Zuckerberg then went on to build Thefacebook. This was the predecessor to today’s Facebook which was incorporated in 2004.
A few years later in the summer of 2009, Facebook came under pressure from the federal privacy commission over privacy concerns. The Canadian government was concerned the social networking website was violating Canadian privacy law, by keeping people’s personal information indefinitely. Facebook was also criticized for sharing users’ files with nearly one million third-party software developers. On July 16th, 2009, Facebook was given 30 days to comply with then Privacy Commissioner Jennifer Stoddart’s recommendations.
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In fact, even if you deactivate your Facebook account, Facebook still stores all your personal information unless you delete it. But therein lays the dark secret behind Facebook, which is really more of a data-mining company through apps and personal profiles, than a real advertising company. Next to Google, Facebook probably has the largest amount of personal information about people on the web – maybe even more. This information is likely more valuable to Facebook for marketing than displaying a billion Bing or Facebook ads. The recent addition of Facebook’s timeline is a scary lesson on just how much information Facebook has about you. The recent time-line not only encouraged me to deactivate my personal Facebook account, but to actually delete it!
At some point Facebook will come under more public and legal scrutiny regarding its privacy policies, now that it is a publically traded company – you can count on it.
(PS If you want to permanently delete your Facebook account, and not just deactivate it, you can do it here. Facebook will give you 14 days from the day you request to delete it, before they actually do.)
9. The Groupon Effect
Groupon (GRPN) was another large internet company that went public in November 2011. From the onset, Groupon was plagued with legal issues surrounding its IPO, with questions surrounding its accounting and revenue practices. Some analysts compared Groupon’s IPO to a Ponzi scheme, and others criticized Groupon’s decision to pay out over $940 million of its venture capital it to its founders and early backers (from wikipedia, see initial public offering filing). It was estimated that Groupon was losing $100 million dollars per quarter.
It’s been a long steady decline for those who bought Groupon on IPO day at $20, or more per share. Although Groupon shares increased some 30% shortly after the IPO, legal issues surrounding its accounting and revenue practices surfaced early on, hammering the stock price. The stock price hit lows of $9.63 per share in May 2012. Today, Groupon now trades at $12.05 dollars per share, -39.7% below its IPO price.
Facebook is already dealing with the legal issues surrounding its IPO, and there may indeed be more questions about its advertising revenue, stock valuation, and profit margins. Like Groupon, although for different reasons, Facebook is already wrangling in legal issues as newly traded company. As an investor, that is not a good sign.
10. Other reasons not to invest
There are other reasons why you shouldn’t invest in Facebook. (1) A recent Globe and Mail article points to Facebook’s intrinsic value which also indicates an overvalued stock price. In that article many analysts give Facebook a share price between $9.69 and $29 per share based on what is termed intrinsic value, and the latter is assuming “Google like growth”. (2) Facebook has a Price to Earnings Ratio of 81, meaning the price of the stock is valued 81 times above its earnings. Investors will often invest in stocks with higher PE ratios of 15 to 20, but 81 is simply dangerous. (3) Zuckerberg is the majority shareholder, with a 57% stake control of voting shares as of the IPO. This means that retail investors have no say in company policy or voting control.
Although Facebook is the second most used website behind Google, it doesn’t necessarily mean it’s a great investment as a shareholder. Facebook may indeed be a worthwhile investment a year down the road, but buying an IPO always has inherent risk. Within the first few days of trading, there are already class action lawsuits against the company and underwriters. Many are already questioning the facebook IPO, lofty stock valuation, and potential for future revenue and earnings. Considering the Facebook IPO has been the largest in history, and there is more room for concern, there is also more room for downside than upside.
If you already own Facebook and your nursing a loss, then consider selling and get out before the real problems hit the fan. These are real considerations, such as: (1) revenue and profit that appears to be misrepresented to retail investors, (2) potentially lower than expected revenue come Q1 reports, (3) a stock valuation that is now confirmed as overvalued, and (4) the beginning of numerous class-action legal suits against the company and its underwriters, which will cost the company money.
Even if you really believe in the facebook business model, you should wait until these major issues are resolved before you buy in. Facebook may follow in the steps of Groupon, with a long declining share price amid legal wrangling, and lower than expected earnings and revenues. Time will tell.
Readers, what’s your take?