The IPO of Facebook and it's Stock Performance

Company Valuation
The valuation and method used to determine the Initial Public Offering (IPO) value of Facebook stock was based on numerous factors. First, it was a much-hyped IPO, with retail investors seeking to get in on the action that venture capitalists had already secured years prior through private investment. Everything connected in one way or another to Facebook was receiving attention, even Zynga, the one-hit wonder PC-game producer. Second, the company’s worth was measured by clicks and projected ad revenue as well as by the number of users of the company’s products. The company had stated a net income of $1 billion in 2011, up 65% year-over-year, indicating that it was steamrolling to profits. With 845 million monthly active users and 483 million daily active users, it was positioned as a great platform for advertsing. Its market cap, however, was a stagger $104 billion at the time of the IPO (a P/E well above the industry average), which led some analysts to conclude the stock was overvalued and the result of a “new financial bubble” (Gajic, Budinski-Petkovic, 2013, p. 208). This may have led early investors to dump the stock soon after its IPO, which could explain the stock’s plunge in the following months to $17.55. It quickly rebounded though and steadily rose with good news coming annually out of HQ. Today, its market cap sits at $496.47 billion. The pricing errors might have been minimized by evaluating external factors alongside internal factors (such as a yield-starved marketplace).
The Facebook IPO was based on the issue of supply and demand as well—the number of shares being sold to the public and the demand from the public for those shares. The public was very aware of how cheaply it could have purchased shares of Google at its IPO price and Facebook was considered to be the next Internet phenomenon. At the same time, there were plenty of skeptics amid all the speculators seeking to cash in on the next big thing (Cauwels, Sornette, 2012). With an IPO of $38 per share on 18 May 2012 and 421,233,615 shares offered, the $16.007 billion raised made it the biggest tech IPO in U.S. history at the time. Immediately following, the share price dipped—but a buyer of the stock at that price would be holding a ten-bagger today as the stock valuation of the company has increased 10-fold over the past 5 years.
The performance of the stock within the first year of the public offering was depreciation followed by appreciation. Indeed, the IPO market in general felt the underpricing was off “and the average level of underpricing increased from 11% pre-Facebook to 20% post-Facebook” (Krigman, Jeffus, 2016, p. 335). The stock initially declined out of the gate, dropping by half. It then recovered to $24.35 by 31 May 2013, peaking at $31 in January of 2013. The drivers of the performance were questions about the company’s ability to make money, and the resulting impact to the company performance was that it essentially stayed range-bound for the entire first year, never rising above its IPO pricing. Investors were waiting to see how its Q1 would look. When quarterly financials began to be released, investors piled in and never looked back.
An alternative method of valuation for the company and how it may have yielded a different value and the potential resulting impact to investor decisions would have been for the company to consider the fact that social media is not going away—and Facebook is not stuck to the original platform either but also can expand—and that is what it aimed to do with mobile technology and platforms like Instagram. With $1 billion in revenue, prior to its IPO, the company was clearly in line with what Modis (2002) recognized as a growth trend blossoming on social tech. Thus an alternative method of valuation would have been to identify the trend that Facebook was in and was, in fact, setting alongside other social media giants—and how that trend would ultimately kickstart its valuation the way that Amazon and Netflix eventually caught on with investors. Assessing the social trend in this sense would be the key to valuation. The potential resulting impact to investor decisions would be that the investor would rightly spot Facebook as a herald of things to come and buy the stock (preferably on its dips) and accumulate a position gradually but prior to the releasing of financials indicating its ability to truly make a significant profit (Cusumano, 2012).
The role of the Chief Executive Officer (CEO) in relationship to the stock performance is also vital. Facebook CEO Mark Zuckerberg is the face of the company: his story was immortalized on film in David Fincher’s The Social Network in 2010—two years prior to the company’s IPO and a good marketing ploy that helped drum up interest in the stock. Prior to the offering, Zuckerberg made many public appearances and met with various investment funds to make pitches as to why the company’s valuation was fair.
Considering, however, that there is a significant amount of pumping that is put into any price, a drawdown in the stock’s price was not totally unpredictable. Having the foresight, on the other hand, to predict the price action over the coming years would have required an understanding of how digital advertising was going to become such a huge focus of so many firms and how Facebook would play a part in that. Combining these insights with the role that central banks would also play in stimulating the U.S. market through quantitative easing and low interest rate policies—thereby forcing more investors into the stock market to obtain the desired rate of return that they needed for either personal investment strategies or for funds (such as sovereign wealth or pension or mutual) that they oversaw—would have been useful information for an investor seeking to gauge the right time to buy in and how long to hold.
The risk/reward position of an investor purchasing stock during an initial public offering would be determined by focusing on the investor’s strategy, whether a long-term growth strategy was in play or whether a short-term trading strategy was in play. Investors could go short or long, depending on how they wanted to position themselves. They could play for swings based on momentum trading indicators, or they could take the long view and determine whether the stock was likely to grow in value over x amount of years.
The circumstances under which I would advise an investor to purchase an IPO would be if that investor was looking to play the long game. IPO’s can be extremely volatile, especially in the beginning, when private investors are looking to exit their positions as retail buyers enter into the market. A recommended word of caution for longs would be to wait for two months before purchasing to allow for private investors to divest and for short selling to end. Negative analyses will likely be published to justify the receding price—and it is at this time that the savvy investor should take advantage of the pull-back—assuming of course that the other conditions are right (such as the various external factors, such as low interest rate policy still in effect, central bank buying still occurring, and so on).
The stock price of Facebook over the next five years is likely to move in the same direction as the rest of the market—and that depends on more than just the fundamentals of the individual companies that make up that market. With P/E’s much higher than historical norms and only a handful of stock favorites really driving the market as a result of passive investing through ETF’s and central bank buying, the market is highly dependent upon externals at this point. However, if one is to gauge the direction of Facebook’s stock price by the company alone, its current valuation is indeed reflective of the company’s actual ability to turn a profit. Be that as it may, not all businesses are buying the advantage of advertising digitally on sites (P&G is one such company that is taking less of a stake in digital advertising). Should Facebook’s ad revenue plunge, the company’s valuation should decline—but this is unlikely to happen.
Should Facebook be bought today at all time highs? This might appeal to risk-on investors, but the global marketplace is signaling several red flags that might lead one to desire a risk-off strategy. Should the market overall adopt a risk-off position, stocks like Facebook could feel the brunt—especially if there is a mass exodus for the gates. With that said, the key drivers of Facebook performance are ad revenue, social media users, and worldwide popularity. Facebook is everywhere and so long as its numbers stay strong and it continues to make strategic acquisitions (like Instagram), the company should maintain its position as a market favorite. With this in mind, its stock price over the next five years could very likely double from where it currently is—assuming that market conditions stay favorable. However, should the market turn away from risk, Facebook may lose a quarter to half its current value. Is this likely to happen? No: the Digital Age is here and Facebook is leading the way. Zuckerberg continues to be in the spotlight as an advocate of social justice and his company continues to be user friendly and a way for people to stay connected and share information. Still, with new social media platforms arriving constantly (Snapchat being the latest to have an IPO), Facebook could lose ground with younger generations. Thus, it is fair to put Facebook’s stock at $125 in the next five years: if the stock market is currently at a peak, so too is Facebook and the movement away from its usage will bring its stock price down.

References
Cauwels, P., Sornette, D. (2012). Quis pendit ipsa pretia: Facebook valuation and
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Cusumano, M. (2012). Reflecting on the Facebook IPO. Communications of the ACM,
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Gajic, N., Budinski-Petkovic, L. (2013). Ups and downs of economic and
econophysics—Facebook forecast. Physica A: Statistical Mechanics and its Applications, 392(1): 208-214.
Krigman, L., Jeffus, W. (2016). IPO pricing as a function of your investment banks’
past mistakes: The case of Facebook. Journal of Corporate Finance, 38: 335-344.
Modis, T. (2002). Forecasting the growth of complexity and change. Technological
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