Friday, the whole world held its breath as the hype, hysteria, and frenzy surrounding the Facebook IPO finally played out. Suspense mounted while the delayed opening “for technical reasons” left the world waiting and watching. Federal Reserve Chairman Ben Bernanke no doubt beamed with pride as his stated purpose to “encourage risk taking” burst forth in all its glory.
Wilt thou set thine eyes upon that which is not? for [riches] certainly make themselves wings; they fly away as an eagle toward heaven. (Proverbs 23:5)
You may have noticed that at the end of the day, whenever the price dropped to $38, the bid lot size pegged at 10 million shares. Clearly, an entity with deep pockets did not want the stock to fall below the offering price. Prime suspects for this action would be the underwriters themselves. Why? For this IPO, underwriters bought the shares for the after-commission price of $37.582. Morgan Stanley signed up for 162 million shares, JP Morgan for 85 million, and others took less. For Morgan Stanley alone, that amounts to over $6 billion that could easily vaporize if they fail to dump this turkey before it declines closer to its newly inflated $5.69 book value.
How many shares did these underwriters sell Friday? The answer to that question has alluded my searches. From the Facebook prospectus, we do have the following figures:
180,000,000 shares by the company
241,233,615 shares by individuals
———————————
421,233,615 shares total
63,185,042 shares over-allotment [optional]
Certainly, many of thes shares circulated as day trades. Yet the total trading volume amounted to just 570 million shares. In a normal market, the price would have fallen to attract sufficient buyers. The makers of this IPO apparently decided to not permit “breaking the offering price.” Instead, they decided to hold the stock in hopes of unloading the hot potato before they ran out of hapless buyers.
We all realize that a public offering enriches private shareholders. The fascinating realization of this IPO to me though was how the sale of stock at an inflated price greatly enhances the balance sheet. Facebook sold 180 million shares for the corporation created out of thin air. Does this sound familiar? That amounts to $6.8 billion dollars that went straight to the Facebook balance sheet and instantly transformed shareholder equity from around $2.85 per share to $5.69 per share.
For that bevy of proud new Facebook owners let’s compare their glistening jewel to Google. After all, each of these two companies earns its revenue by selling advertising on the Internet, so the comparison makes sense. (The source from which the following figures are taken or derived come from finance.yahoo.com.)
| Factor | |||
|---|---|---|---|
| Market Cap | 196 B | 105 B | |
| Shares | 0.33 B | 2.74 B | |
| P/E | 18.2 | 88.3 | 4.85 |
| Price/Book (pre-offering) | 3.29 | 11 | 3.34 |
| Revenue/Yr/Market Cap | 0.20 | 0.04 | 5 |
| Net Income/Yr/Market Cap | 0.056 | 0.0062 | 9 |
| EBITDA/Market Cap | 0.07 | 0.02 | 3.5 |
| Free Cash Flow/Market Cap | 0.077 | 0.0156 | 4.9 |
Each cell in the column labeled “Factor” in the table above indicates how much better the Google value is compared to that of Facebook. Based on this simple analysis, I’d say Facebook’s IPO price comes in around five times it’s reasonable value. A price of $8 a share wouldn’t surprise me as a near-term target for this turkey. In summary, Friday’s Facebook IPO gives us the latest example of foolish money chasing an illusion. The quote (incorrectly attributed to P.T. Barnum) “There’s a sucker born every minute,” still rings true today.
Week in Review
Looking back at last week, we see that Monday renewed the stock market decline that started this month. Hope for more monetary accommodation that fueled the former mania in stocks continued to wane. The current downturn in large part related to the realization that more of the same may not be forthcoming. As reality sets in, the cries for QE3 continue to grow fainter.
The worry of the day centered around Europe. During the weekend, Greece had failed to form a coalition government. Reports surfaced that Greece may not be able to pay its bills as soon as next month. European stocks closed down nearly 2%. The Greek 10-year government bond interest rate skyrocketed to greater than 27%. Spanish 10-year bonds followed suit, jumping to over 6.2%.
Meanwhile, the U.S.Treasury Bond rate plummeted to 1.78%, the dollar index jumped to 80.60, and the VXO rose to over 21. Gold and silver continued their sharp decline. The next day, Tuesday, Greece would either have to pay the holdout bond holders, who refused to settle on their bonds, or default. That may explain the wave of selling into the close Monday that took the highly pumped over-valued IBM below its magic 200 level, dragged the Dow down below 12700, and pulled the S&P below the key 1340 level. Selling remained orderly though with volume on the light side of moderate.
Tuesday, shortly before stocks opened in New York, Greek officials announced they had failed to form a coalition government—increasing uncertainty and setting in motion the need for another round of elections. This event dragged down stocks in Europe, although a slightly positive GDP number in Germany had cheered investors somewhat. Greece also announced that it would not default on the holdout bonds owned by those who did not agree to converting them and taking a 75% loss. While Greece has the cash at the moment (thanks to the most recent bailout), the bond payment will make a big dent in their account.
Greek, Spanish, and Italian bonds each deteriorated badly again. This article from Zero Hedge paints a very bleak picture of the financial status of European banks. In response to this news, European and U.S. stocks cascaded downward another 1%. The VXO fear reading closed above 22 and the dollar index soared up 0.61 to close at 81.22. Over the span of just two trading sessions, the dollar index has risen nearly a full point. The Dow dropped decisively below the 12700 level, NASDAQ slipped under 2900, and IBM again breached the 200 level to close at 199.
Wednesday Asian stocks took a beating, but European and U.S. stock markets calmed. With the exception of the Greek 10-year bond, whose interest rate spiked to within a whisker of 30%, bonds of the other troubled EU nations took a breather. Stocks tried to rally back a bit with fear dropping a little. By noon, investors put trading on hold awaiting the minutes of the FOMC in hope there might be some encouraging word that the committee will respond soon with QE3.
Sorry, Charlie. The minutes contained no immediate hope for QE3. On the contrary, they acknowledged higher inflation and lower unemployment. The minutes also contained detailed graphs of the specifics of member opinion while maintaining their anonymity. The consensus strongly supported an unchanged policy stance.
The report also showed a surprisingly wide distribution of opinions regarding the timing of future actions. As a result, the stock market closed mildly lower on moderate volume. With the Dow below 12600, NASDAQ below 2900 and S&P below 1330, we witnessed a clear break below technical support. The way I see it, the next stop (not a floor) would be the 200 day moving average down around S&P 1280.
Thursday morning Spanish banks again grabbed the headlines. A bank run on Bankia, the “bad bank” concocted by the government, has pummelled its stock and likely sealed its demise. Moody’s announced an immanent downgrade of Spanish banks. The Spanish 10-year bond interest rate soared to over 6.3%. Things do not look good for Spain. Later in the day, Fitch downgraded Greek bonds.
While Asian stocks weathered the day unmoved, the European stock markets have again dropped over 1%. Stocks in the U.S. posted mild losses in comparison to start, but as the day wore on prices dragged lower. Uncharacteristically, gold and silver spiked upward and their mining shares skyrocketed after a dismal Philadelphia Federal Reserve business outlook survey at 10 AM revived hopes of QE3.
What a difference a day makes! This move by gold upward while stocks fell fails to match the deflationary pattern associated with the current financial quagmire. Renewed QE3 hopes do not line up with a diving stock market.
The U.S. Treasury Bond bubble inflated even more—dragging that rate down to 1.70%. Fear continued to mount as confirmed by the VXO ticking upward nearly two points to 24.07 as it too closed in on its 200 day moving average. The major indices lost about 1.5% with the big decline coming near the close. The S&P 500 closed at 1304.86 as stock indices continued to erode their 2012 gains. Although IBM has much further to fall and despite all of the pumping, the stock closed below 198.
Let’s try to sort this out. The dollar index remains strong. Precious metals, their mining stocks, and U.S. Treasuries surged. Stocks tank. Bank runs, ECB tough talk, political upheaval, and riots point to fear of contagion in Europe. Treasuries up and stocks down fit the “risk-off” sentiment. A strong dollar correlates with distrust of the euro. The puzzle that remains applies to the sudden surge of gold and mining stocks. The timing of the sharp rise (10 AM Fed report) gives the best clue.
From Bloomberg we have this perspective:
After the market closed, Moody’s Investors Service confirmed investor speculation as it cut credit ratings for 16 Spanish banks, citing economic weakness and the government’s budget strain.Investors are locking in profits after the stock market’s rally earlier this year and are putting their money into Treasury inflation-protected securities, precious metals and defensive consumer names as they anticipate a third round of quantitative easing….
Friday, various other news reports noted the near-record low of the 10-Year U.S. Treasury Bond and record low of 10-Year TIPS rates (safe investments) correlated with the increasing flight from stocks (risky investments) evidenced not only by falling prices but also by 52-week new lows swamping 52-week new highs. Reports also speculated that gold’s sharp upward move may indicate its a reemergence as a safe-haven. While this could be true short term, as stock losses snowball, I believe deflationary forces will again suck precious metals back into this vortex.
The Nikkei dropped 3% to 8611. Europe meandered. Despite expected downgrades of Spanish banks by Moody’s, Spanish and other European bond rates declined somewhat. The S&P 500 Index closed in on its 200-day moving average, ending the day at 1295.22 on strong trading volume, even excluding the over 500 million shares of Facebook that traded.
For the week, U.S. stocks dropped another 4%, precious metals ended even, the dollar index gained a point, AAII sentiment strengthened its bearish reading, VXO fear index rose 20%, and U.S. Treasury Bond rates dropped another 8% to settle in near a record low of 1.70. Europe fared worse—especially southern European bonds and banks. While U.S. stocks remain positive for the year, most of the rest of the world has already taken a dive as shown in this article from Zero Hedge.
Is this correction over? No one knows the future except God, but the better question is “Does this Facebook feeding frenzy mark a characteristic sign of the times and blowout event in this current equity bubble?” At the very least, it serves as another big clue that investors are far too anxious to own stocks. In the short term (a day or so), if their buddies (JP Morgan, etc.) need a lifeline from the Facebook sinking ship, the PPT will “act to stabilize the markets.” After that though, I also believe the Fed will refrain from increased support of the stock market—allowing it to proceed further downward at least until fear reaches levels seen last October.