The biggest positive news in mid-May was the much-hyped IPO of Facebook. Throughout the week preceding its launch, both the IPO price and the number of shares offered crept higher, suggesting the investment bankers positioned the deal a little too aggressively.
Several institutions claimed the revised price made the deal too rich for them and the shares did not pop higher the way they were expected to.
The Facebook deal was the only thing investors had to cheer about in a pretty dismal week; markets continue to focus on Europe’s struggle to cope with Greece’s inability in forming a new government and New elections had been called for June, which was rumoured to prelude tan early Greek departure from the Euro currency.
Much of the negative sentiment in the market was attached to global banks, with Italian and Spanish banks being downgraded and the JP Morgan story continuing to weigh on investors.
Even the 50-basis-point cut to Chinese bank reserve requirement ratios didn’t not lift the mood. The TSX dropped and Canadian stocks rallied with rising gold shares, since gold rose on speculation we were moving closer to another round of Central Bank monetary stimulus.
Economic data was mixed and offered little support to riskier assets. U.S. Industrial Production and German GDP were encouraging, but weekly jobless claims remained stubbornly high and April retail sales were soft in the U.S.
What is Facebook really worth?
As you know, Facebook went public on May 18 in a much-anticipated debut on the NASDAQ. Facebook is the largest online social network in the world and boasts over 900 million active monthly users.
Regular users click the “Like” button over 3 billion times every day, which helps create a user database, which Facebook hopes to monetize for shareholders.
As well, the Facebook platform is used for over seven million third-party applications and is one of the largest online display advertisers in the world. In short, the Facebook social network is one of the “stickiest” and most popular websites in the world. The IPO valued the company at $100 billion but analyst valuation models and revenue forecasts valued the company at far less.
And it seems they were right, with stock prices having now settled around 20% lower than the company’s original $38 share price.
To try to figure out its true value, you have to understand how Facebook earns its money. Facebook currently earns revenues from display advertising on its website and royalties from third-party developers that create original content for its platform.
The stock market value is predicated on Facebook’s ability to continue its exponential user and revenue growth.
Keep in mind, much of the company’s recent user growth has been limited to emerging markets and mobile devices. Average revenue per user is substantially less in those markets compared to the developed markets, and Facebook has not been able to successfully monetize its mobile users, who total approximately 500 million of their users.
Facebook is prohibited from entering China, Iran, and Syria, which collectively represent almost one quarter of the global population of Internet users.
Facebook’s IPO price of $38 was based on very aggressive user and revenue growth assumptions. These assumptions were predicated on Facebook’s ability to successfully monetize mobile users, and a belief that increasing market share would increase revenues and profits. Although Facebook saw incredible growth in the last several years, it is quickly reaching its limit, and our valuation models predict slowing revenue and user growth.
Stocks trade on either their fundamentals or the euphoria that surrounds the story, and those looking to allocate capital new names should weigh what it is they are paying against what they believe they are getting.
Click below to see what Andrews predicted would happen as May trading came to a close.
HEADWINDS FOR RESOURCES
There is no escaping the close relationship between the Chinese economy, the global commodities price index, and ultimately a big component of earnings on the Canadian TSX index. Commodities are now touching Q411 lows and a big part of that is the economic slowdown in China. Despite the media’s fascination with Europe, the People’s Bank of China (PBofC) quietly cut the level of reserves Chinese banks maintain. Commodity prices have usually remained under pressure from the time the PBofC begins to ease finished their cycle. This is their third Reserve Ratio cut since December and another 3 or 4 cuts could be expected. Therefore, the resource heavy TSX index could remain under pressure until the Chinese easing campaign ends.
TRADING WEEK AHEAD
Investors always remain hopeful but are usually left underwhelmed when world leaders decide to spend the weekend together. The G8 congregation at Camp David in Maryland this weekend
should prove to be the same.
The discussions will be how to manage a responsible approach to the European debt crisis and the situation in Greece. Markets will likely face the same macro headwinds with a focus on Europe in the week ahead. With investor optimism at such depressed levels, we would not be surprised to see a technical reversal in the near future.
The recent slump in stocks has been both fast and steep, and as such, technical momentum indicators now suggest we are now overdue for a reversal. For a reversal bounce in the stock market to be sustained, either the macro data will need to improve or additional policymaker stimulus will be required. We might get a catalyst out of next week’s economic data.
The week’s economic data will include April U.S. home sales and durable goods orders. On Tuesday, both new and existing home sales should show an advance with existing home sales expected to reach the highest level since May 2010 (during the homebuyers’ tax credit frenzy). This would be supportive of the stock market.
Durable goods orders for for April (Thursday) may possibly fall for a second straight month, marking the first back-to-back declines in durable orders in two years. The Canadian data calendar for the holiday shortened week will include March retail sales. Sales should show a reversal of February’s decline and actually rise at the fastest pace in five months.
The data may be misleading as the increase has more to do with higher prices than higher sales volumes. Gasoline costs will be the biggest contributor to the higher number.
David Andrews is the Director, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends.
@David_RGMP