A steep climb back for Facebook's stock

By Somini Sengupta, The New York Times | Updated: 13 August 2012 13:23 IST

The Facebook spring is over. The dog days of August have taken hold.

In May, when investors tripped over themselves to buy a piece of Facebook, not even the skeptics predicted what has happened. Three months after the offering, shares have lost more than 40 percent of their value, closing at just under $21.81 on Friday, from $38 on May 18.

The stock began to dip immediately after its debut on the public markets, and at first technical errors with the offering were blamed. But these problems did not account for the stock's subsequent plunge, analysts and shareholders say. That decline, they say, can be traced to several factors, among them the sheer size and price of the initial offering, early exits by major investors and slowing growth.

Not least, the stock seems to have been jinxed by Facebook's own fairy tale.

"The underwriters (and the media) did a great job of hyping Facebook leading up to the I.P.O., and the sell-side (including me) did a great job of hyping it after," Michael Pachter with Wedbush Securities, an equity research firm, wrote in an e-mail.

Still, some investors remain bullish. Facebook is profitable, it keeps its nearly one billion users glued to their screens longer than any other Internet site, and it is aggressively experimenting with new ways to drum up advertising - its main source of revenue. Just this month, for instance, it began offering application developers a way to focus ads, and sought to diversify revenue by opening its site in Britain to online gambling.

The next test for the stock could come soon. Over 1.6 billion shares will be eligible to come on the market in several waves, starting on Thursday, when a number of shareholders are allowed to sell. Investors may fear that an influx of shares could cause prices to fall even more.

"It becomes a company perceived as vulnerable rather than invincible," said David B. Yoffie, a Harvard Business School professor who sits on several technology company boards, though none that relate to or compete with Facebook.

Facebook executives say they remain focused on expanding. They declined to comment on the stock price, but in late July, in a conference call with analysts to discuss the second-quarter earnings, David Ebersman, the company's chief financial officer, said he was "disappointed" in the stock dive. On Friday, Mr. Ebersman was in New York speaking to investors, current and potential.

One former Facebook employee, who did not want to be named because he did not want to damage his relationship with onetime co-workers, said he expected other employees to cash in their stock options as soon as they could, and predicted that the stock's woes could make it difficult to retain and hire talent. He no longer owns Facebook stock.

The former employee pointed out that many of the company's early big backers - including Peter Thiel, an original angel investor, and Accel Partners, one of its first venture capital investors - sold a hefty portion of their shares at the peak price.

Mark Zuckerberg, a co-founder and chief executive, sold a portion of his shares in the offering, to meet his tax bills, the company said. All told, the early backers sold over $9 billion in shares. They still own significant amounts.

Kevin Landis, chief investment officer of Firsthand Funds, an asset management firm, now has to weigh what to do with his piece of Facebook. Late last year, he bought what were then coveted Facebook shares on the private market. On average, his shares are now worth about two-thirds of what he paid. Under the purchase terms, he may not sell until late this year.

It's not "a good feeling," he said, but he added that he remained confident that with so many users and so much data about them, Facebook was destined to be the most lucrative advertising platform in the world.

"Right now there's a separation between the people who bought in because it was hot and the people who believed it could be one of the most valuable franchises," Mr. Landis added.

The company certainly was hot earlier this year. The public offering was pegged at a market value of over $100 billion. And the company's growth figures seemed extremely alluring.

Facebook raised its user base at rocket speed since its start in 2004, to 845 million in February. Revenues swelled to nearly $4 billion in 2011 - nearly a fivefold increase in two years. Facebook was only beginning to figure out how to make money from the stream of personal data that its users reveal about themselves.

The company's Wall Street debut was the biggest to come out of Silicon Valley, far bigger than Google's in 2004 or Netscape's a decade earlier.

But Google did not set hard-to-beat expectations, and by the time it went public it had a sure way to make money. Apple has typically set low expectations, and just as typically surpasses them.

After its early dip, Facebook's stock rallied briefly in early June and settled at just under $30 by July. But in late July, it took a hit when Zynga, which makes games to play on Facebook and shares revenue with the company, reported weak earnings. The next morning, after Facebook's own earnings report, its shares slid again.

In the end, the performance of the company is what will matter. Right now, Facebook's immediate challenge is making money on mobile, where more than half its worldwide users are logging in. It has only recently and cautiously started advertising in the mobile arena. Regulatory scrutiny also continues to be a risk, depending on how the company handles user data.

After the earnings report, Facebook executives said their experiments in increasing revenue were bearing fruit. The chief operating officer, Sheryl Sandberg, said in the analysts' call that Sponsored Stories, a form of Facebook advertising, was bringing in $1 million every day, half of which came from mobile users. Sponsored Stories turn a Facebook user's "like" of a brand page into brand endorsements to his or her friends.

But Sponsored Stories are also the subject of a federal class-action suit in California. A pending settlement could be costly.

The company reported that revenue increased 32 percent in the second quarter, to $1.18 billion, compared with 45 percent in the first quarter. From the second quarter of 2010, and in all of 2011, revenue expanded by 88 percent.

Ms. Sandberg said it would take more time for marketers to figure out Facebook. "It took a long time for the TV market for advertising to be understood," she told analysts. "We are still in the learning curve."

The morning after that earnings call, Morningstar Inc., the investment research firm, predicted that the stock would continue falling for the next several quarters and advised investors to buy only when it falls to $19.20.

The price has hovered near $20 since. Last week, Reed Hastings, the chief of Netflix and a Facebook board member, bought more than $1 million of shares, at an average price of $21.03.

Mr. Pachter said he had begun to detect anticipation. Some prospective investors are asking him: "When does it get stupid cheap?"

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