Dear Fellow Technophiles,
Some issues in events in popular society are
simply too big to be missed. The OJ trial. A "Royal Wedding."
Facebook's IPO. In all the aforementioned cases, I did my own personal best to
be as far from the action as possible when the fateful day came. It's not a
lack of interest, but just a time-tested life lesson that the real
opportunities in life are where the circus has yet to land.
Still, at Casey Research we're not content to
simply write off a profit-making opportunity to "carnie wisdom." And
thus, we took a hard and close look at the Facebook IPO for Casey Extraordinary Technology
subscribers. The result of that detailed analysis? Stay as far out of the way
as you can. We made sure that subscribers understood that given the
"muppet demand" on one side, the insiders cashing out on the other,
and the banks taking billion-dollar paydays for nothing other than their
government-mandated oligopolic postions in the middle, there was no play for a
smart individual investor, long or short.
Yet even we didn't see the Nasdaq's side. So,
despite our desire to turn our attention back to the companies still creating
value for individual investors, we felt little choice but to delve one last
time into the IPO waters to try to explain why, only six days later, we find
accusations of malfeasance being thrown around like confetti, lawsuits
mounting, and big questions now being asked. So, our own Adam Crawford tries to
break down one of the most complex financial events of the decade in 1,000
words or so of as plain an English as can be done.
Sincerely,
Alex Daley
Chief Technology Investment Strategist, Casey Research
By Adam J. Crawford, Junior Analyst
In less than a week's time, the Facebook IPO
has gone from the most-hyped technology event since Google went public into
"blame-storming" mode. Details concerning the stock's sudden drop,
the market's inability to process orders, and the (mis)behavior of insiders are
starting to emerge. And it doesn't look good.
The Scandal
When any stock drops as much out of the gate
as Facebook has - down as much as 25% peak to trough in the days since the
public premier of the stock - people start asking big questions... even more so
when that stock carries a $50-billion-plus market cap, meaning the loss
triggered billions in paper losses. Add on the fact that the Nasdaq market
computers crumbled under the activity, and the scrutiny is intense.
What's been uncovered so far is painting a
picture of poorly managed expectations and questionable ethics. The key event
behind the drop appears to be a massive shift in expectations from
institutional investors at the last minute.
Evidently, a Facebook executive - at this
stage we can only guess who - alerted analysts that previously issued revenue estimates
were a bit optimistic. Shortly thereafter, the analysts took the unusual step
of slashing revenue estimates during Facebook's IPO roadshow. The information
was then relayed to a select few potential institutional buyers. The financial
community calls this "selective disclosure." I call it BS.
To make matters worse, Morgan Stanley (the
lead underwriter and one of a select group of banks privy to the lower
estimates) actually raised the offering price and issued more shares publicly,
despite cutting the revenue estimate behind closed doors. Initially, Facebook
shares surged due in large part to robust retail demand. However, once gravity
took hold, Morgan Stanley chose to step in and provide some temporary support
at the original offering price of $38 a share. The bank stepped into the market
and bought millions of shares back from the public. It was able to do so
without risking much capital thanks to the massive "greenshoe"
allotment it took at the IPO - a gift of nonexistent shares the bank can sell
risk free to the public if they have the demand. Stock goes up, and Morgan
Stanley can force Facebook to cough up more shares, diluting investors and
pocketing the profit. Stock goes down, and Morgan Stanley can buy them back
below the IPO price, wiping out the excess volume and pocketing the price
difference. Not bad deal, eh? Thankfully, most banks do exercise some level of
ethical caution with those overallotment shares and use the process to instead
stabilize the market, as happened with the over 60 million shares Morgan
Stanley bought back from investors.
Consequently, Facebook shares stabilized and
ended the trading day flat.
Facebook's humdrum opening-day performance was
a minor disappointment for speculative investors hoping to flip shares for a
quick profit. The minor disappointment soon morphed into a major disappointment
for all shareholders, once rumors spread about the behind-the-scene shenanigans
mentioned above. One look at the stock chart will show you the unpleasant
Monday-morning surprise shareholders arose to the next trading day.
(Click on image to enlarge)
Facebook shares have since settled near $32 a
share but remain exceedingly temperamental. A skilled trader could probably
make a few bucks off this volatility (but a day trader I am not, so I can't
help you there). As far as Facebook's long-term potential goes, I can offer a
quick analysis.
The Future Outlook
Despite our decrying of the trading practices
of Wall-Street banks, when dealing with a company of this size and whose
relationships with the banks run this deep, one of the best sources of data on
the company will remain the consensus opinion of their research arms. Below are
their earnings-per-share growth estimates for the next three years:
As you can see, earnings growth is projected
to slow to 21% by 2014. That's exactly the growth rate Google - a company with
nearly 10 times the annual revenue of Facebook - is estimating for 2012. And
for that kind of projected growth, the market places a value of 18.5 earnings
on Google's stock. Let's be generous and award Facebook a 25 multiple for 21% growth.
A little back-of-the-envelope math suggests that would place its value at about
$20/share ($.80 EPS x 25) three years from now!
Coming at this from another direction, let's
assume that cash flow and net income will be the same in the years ahead. Let's
further assume the same growth rates shown above for 2012-2014 and add these
rates for subsequent years:
When we apply a 10% discount rate to these
data, we come up with a discounted cash flow valuation of $27.
With either approach, Facebook appears to be
overvalued based on the ultimate arbiter of value, profitability. But the
picture may be even worse than we've painted. Every assumption depends on
tremendous - yes, slowing, but still on the "billions of dollars per
year" scale - growth; and there are red flags popping up all over the
place in that regard. Here are a few:
- General Motors, questioning their effectiveness, recently withdrew its display ads on Facebook. (Speaking of General Motors, Facebook's market cap is bigger than GM's and Ford's combined!)
- Revenue from advertising on mobile devices is likely to disappoint; the screens are simply too small and commerce activities less common and for lower value, to be as effective at advertising.
- In his IPO letter, founder Mark Zuckerberg wrote: "We don't build services to make money; we make money to build services". In other words, maximizing revenue is not his priority. He is reluctant to extend ads beyond a certain point because he believes they become intrusive and compromise the experience. Noble as this may be, it will hamper the growth needed to justify the stock's lofty valuation. Of course, Zuckerberg is a billionaire still at $27, $20, even $5 for the stock...
The Winners and Losers
With the company's stock dropping, retail
investors getting the hose, and profit opportunities coming, did any of the
stakeholders win in the IPO process?
The primary loser in Facebook's market debut
appears to be the retail investors, because they were sold shares at an inflated
price, based on inflated estimates that the investment banks making them knew
to be wrong. However, it's possible that Facebook will turn out to be a
profitable investment still; and if it is, my hat's off to you for taking the
leap - we were busy focusing on opportunities with the odds more in our favor.
A close second in the loser category is
Nasdaq. The exchange lacked the technology to properly handle the massive order
flow, an ironic twist for the de
facto "technology exchange," and the original electronic
trading platform that once decried the failures of the NYSE to meet customer
demand. As a result, many orders were either delayed or altogether failed to
process. Obviously, the botched job could cost the exchange future business.
The primary winner is Mr. Zuckerberg for
numerous reasons... 19.1 billion or so little green ones.
His cohorts also did fairly well, too. Here
are just a few examples:
Facebook employees made out well on the deal,
too... at least the ones there early enough to get sizable grants. We'll know
pretty soon just how many millionaires the event created, we're sure - but it's
safe to assume quite a few. Let's just hope for their sakes that the reality of
earnings potential doesn't hit too hard before their lockout periods expire.
In addition, some savvy traders apparently got
in near the offering price and jumped ship in the $40s - probably a
high-frequency trading firm or two.
The underwriters (e.g., Morgan Stanley) go
into the "yet to be determined" category. Sure, they made a mint on
the deal, but they also have drawn the attention of the busybodies in
Washington, D.C. And any time Washington busts out the red tape, we all lose.
We also like to believe that Casey Extraordinary Technology
investors were also winners in the process. They had straightforward advice to
avoid what has proven to be a disaster of an IPO for both buyers and short
sellers alike. But being successful at choosing what not to invest in is
generally a much simpler task than finding the opportunities that do
legitimately contain a solid chance of producing outsize returns.
We believe, though, that we have proven
ourselves there as well, which is why we publish a full track record of all of
our picks in each and every issue. In fact, we have a handful of promising
biotechnology companies in particular which we think are excellent buys right
now.
So I encourage you to take CET for a spin for 90 days. If you don't
think you'll make your money back and then some after seeing what we have in
store, then just hit reply and tell us so - we'll refund every dime you paid.
But - surer than betting on the Facebook face-plant, I'm willing to bet that
you will stick around once you see what we can do for your portfolio.
At about 4 a.m. Eastern time on Tuesday, Elon
Musk's company Space Exploration Technologies Corporation (SpaceX) successfully
launched its Falcon 9 rocket along with the unmanned Dragon capsule toward the
International Space Station. The historic event marks the first time a private
company has sent a spacecraft to the space station. But it's not a complete
success just yet. The capsule will attempt to dock with the outpost Friday
morning and is currently partaking in flyby tests before arriving at the
station. Dragon is due to deliver food, supplies, and science experiments to
the orbiting laboratory as a test mission for NASA's Commercial Orbital
Transportation Services (COTS) program.
Introducing
the Leap
(The Week)
You will soon be able to control your computer
with Minority Report-style
gestures thanks to a Lego-sized motion sensor from startup company Leap Motion.
Yes, this sounds like Microsoft's Kinect device, but the Leap goes even further
because it "can sense motion down to the most subtle movements of a
finger." The company reports that the device is 200 times more sensitive
than anything else on the market. Scheduled to ship this winter, the Leap plugs
right into your computer's USB port and will be priced at a very affordable
$69.99.
Anticancer
Protein Easily Extracted from Soybeans (Journal of Agricultural and Food
Chemistry)
It's been well documented for some time that the incidence of certain
common cancers of the alimentary system (i.e., the body structures involved in
preparing food for absorption into the body and excretion of waste products) is
much lower in people from Japan than those from North America and Western
Europe. And it turns out that the importance of the humble soybean to Japanese
diets may be the reason for the lower rates of these cancers. Now, a group of
plant scientists at the University of Missouri has demonstrated that copious
amounts of the natural anticancer drug known as the Bowman-Birk Protease
Inhibitor (BBI) can be obtained simply by soaking soybeans in warm water. While
there's more testing to be done, the scientists think this method could be
exploited as a simplified alternative for the preparation of BBI concentrate,
which is being used as a cancer chemoprotective agent.
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