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Facebook IPO Casts Shadow Over All Web IPOs
Although the Facebook (FB) initial public offering (IPO) was wildly successful for the company, it has been much less so for investors. In fact, by some accounts, it is one of the worst performing IPOs of all time. That’s an amazing turnaround from much of the pre-IPO hype. In fact, at one point, it seemed like this one company going public would change the world—if the hyperbole was to be believed. Unfortunately, shortly before the big day, cracks began to appear in its business model and it’s been downhill ever since.
To be fair, the broader stock market has been relatively weak since the dominant social network went public. So, some of the decline could be attributed to other factors. Still, the weak showing has resulted in something of a contagion. For example, Zynga (ZNGA), Pandora (P), and Groupon (GRPN) are all trading below their IPO prices.
Zynga is an interesting case, since its revenues are so tightly tied to Facebook’s customer rolls. Indeed, the casual-game maker, best known for games like FarmVille and Mafia Wars, generates the vast majority of its revenues from games played by people using Facebook. In fact, the company’s 2011 10-K included this warning: “We generate substantially all of our revenue and players through the Facebook platform and expect to continue to do so for the foreseeable future.” While Zynga has been attempting to shift usage to other platforms, including its own recently launched website, as Facebook goes, so goes Zynga. The interesting thing about this relationship is that Facebook’s quest for additional revenue could actually hurt Zynga.
Zynga benefits from Facebook’s network effect—in simple terms, more people in one place start to make that place more “powerful” in many ways. In the social-game maker’s situation, Facebook creates a vibrant social network from which to acquire customers who play its games and, with any luck, buy its in-game digital products (like tractors in FarmVille). Unfortunately, one of the primary ways being suggested for Facebook to increase revenues is to boost advertising on its site. This would likely require exposing user information to advertisers, something the company has been loath to do so far. For good reason, too, since the mere mention of increased advertising, with or without greater use of customer information, creates a decidedly negative buzz in the media and among Facebook’s users. So, it seems like Facebook making more money could mean the network will have fewer users. Less users could mean fewer people playing Zynga games—so much for the network effect. It seems like investors have a good reason to be concerned about Zynga in the near term if it can’t quickly shift usage to other platforms.
Neither Pandora nor Groupon rely as heavily on Facebook as does Zynga, but both share aspects of the social network model that drove the Facebook clamor. Pandora provides streaming music for free, selling advertising to pay the bills, including the cost of the music it distributes. The service has generally been given high marks. However, the ability to generate significant revenue through advertising requires that the company have a large base of customers. Without a material customer base, the amount of money Pandora can charge advertisers goes down. If Facebook is challenging the model of free offerings with advertising, Pandora’s model must, inherently, be questioned, as well.
Groupon, meanwhile, also benefits from a large installed base of users. However, it has a more direct path to profits than any of the above-mentioned companies. It is more like an opt-in direct mail service, since users have specifically joined Groupon to get “deals”. This is, obviously, what interests advertisers. Groupon also benefits from the fact that it has a “neighborhood” focus, providing deals that are specific to where its users live—information that users shared, ostensibly, without any concern. The only problem is that attracting small advertisers is a labor intensive effort; while some might seek Groupon out, many more have to be cajoled into spending money to advertise using the company’s service. Part of the reluctance is based on the steep discounts that have to be offered on Groupon.
Since advertising to users isn’t an issue for Groupon, Facebook’s negative overhang on anything that requires a large network of users is likely part of the problem facing Groupon. The costs associated with getting advertisers shouldn’t be pushed aside, either, but they seem more likely to be a secondary issue in the recent downdraft. Not helping matters for this company is the fact that the “lock-up” period (in which insiders aren’t allowed to sell shares after an IPO) just recently ended.
Although the company’s three founders, Eric Lefkofsky, Bradley Keywell, and Andrew Mason, didn’t sell shares on the day the lock-up period ended, and report no plans to do so, enough selling took place that market restrictions on short selling were imposed. This could, of course, be a mere confluence of events, whereby investors, potentially including insiders, concerned about the market in general wanted to lock in gains to avoid the types of situations that followed the dot.com bust in the early part of this century. Indeed, many once dot.com millionaires lost everything and, adding insult to injury, found they still owed taxes on the money they no longer had.
LinkedIn (LNKD) has also seen its shares come under pressure of late. This company provides a very similar service to Facebook, only for the professional set. While advertising is an important part of its business, professional services are also a factor, likely making its business model stronger than Facebook’s. Still, if social networks prove to be a fad, than LinkedIn’s future has to be questioned. Since the two companies are the most dominant players in the social network space, if one’s model is questioned, the other’s must be, as well, regardless of the differences, which in this case are reasonably large. Still, from an investor’s point of view, LinkedIn is still a winner, since it remains well above its IPO price.
Facebook’s IPO has seen virtually nothing but negative press. From an investor standpoint, this is probably justified. Unfortunately, the concerns about Facebook, many of which are legitimate, have cast a wide net in which other companies have been caught. (Note that some of the concerns about the Facebook IPO appear to be little more than resentment about the fact that the stock didn’t “pop”.) In some cases, investors have good reason to rethink a company’s outlook (Zynga), but in others it looks more like tossing the baby out with the bathwater (LinkedIn and Groupon).
Subscribers interested in understanding the individual situations surrounding Zynga, Pandora, Groupon, and LinkedIn should consult Value Line’s regular quarterly reports on these companies, while keeping an eye out for Supplemental reports covering late-breaking news.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.