Trade Update Facebook (FB): Closing Nov/Jan 22 Calendar For What I Paid

by Dan October 19, 2012 10:52 am • Commentary

Trade Update Oct 19th, 2012 at 10:30am: Since initiating the Nov/Jan 22 Calendar Call Spread in late Aug FB has been all over the place, rather than playing for a bounce I decided to try to thread the needle a bit between the Nov Lock-Up Expiration and what I felt could be a late year/new year rally in the depressed shares.  Given GOOG’s commentary and results yesterday, I have significantly less confidence that FB has any near term fixes to what seems to be plaguing online advertisers as consumers shift computing habits towards mobile and away from the far more lucrative desktop.

Action: Sold to Close FB (18.97) Nov/Jan13 22 Call Spread at .45, what I paid for it.




Original Post Aug 31st, 2012:  New Trade Facebook (FB): We Unfriend Nov & Like Jan

Here is a preview of what I will be discussing tonight on Options Action on CNBC at 5pm:

Facebook has for the time being, re-written the book on how NOT to take your once well liked company public.  The sentiment shift as it relates to both the prospects for the stock and the company has been massive in a relatively short period of time, from the May pre-Ipo fever pitch to the continued hate selling by both early sophisticated private backers to the unsuspecting investment public.

I have 100% avoided the stock because I am not a fan of the company’s product.  While I clearly recognize the growth potential, I guess the cynic in me questions the company’s ability to monetize the ~900 million users (I suspect at least 20% are flat out dormant) in a way that they can ever grow into their heft valuation.

This morning a couple banks took their price targets and estimates down on FB, here is a great recap from Tiernan Ray from Barron’s:

Shares of Facebook (FB) are down 78 cents, a little over 4%, at $18.31 as the stock comes under some heavy pressure from several analysts who are cutting their price targets, mostly based on concern that the expiration of insider sales lockups, which began this month, but of which the biggest is yet to come.

There is also concern about revenue from advertising. As Bloomberg’s Lisa Rapaport and Brian Womack this morning report, research firm EMarketer has cut its projection for the company’s sales this year to $5.04 billion from a prior $6.1 billion estimate, which is still a bit above the Street’s $4.93 billion estimate.

Perhaps the biggest cut today is by BMO Capital’s Dan Salmon, who lowered his price target to $15 from $25, while reiterating his Underperform rating.

One concern, writes Salmon, is that his “checks” reveal that ad spending is “mixed,” as “many conversations referenced a “pause” in order to reevaluate earned/owned/paid mix and ROI measurement.”

But the bigger concern, he thinks, is that investors just don’t care much at all about the fundamentals of the business as long as the lockups are coming off:

But Street FB sentiment is now much worse than advertiser sentiment. We expect investor attention to return to fundamentals after the technical challenges presented by lock-up expirations over the next six months have been absorbed by the stock (possibly offset by some index buying at some point). 

Merrill Lynch’s Justin Post, reiterating a Neutral rating on the shares, cut his target to $23 from $35, writes “Facebook has multiple lock-up expirations over the next year (see Table 1) and recent selling activity on the August lock-up suggests to us the risk of future selling pressure. The biggest lock up date is 11/14 (40% of shares eligible for sale), and we wouldn’t expect stock to see buying momentum until December.”

Still, Post sees possibility for upside in the business next year based on some trends in advertising:

We see the success of new ad formats as paramount for the stock as the direction of revenue growth from here (acceleration or deceleration) expect this to drive stock sentiment into 2013. Also, we think the Street has overlooked positive Sponsored Story revenue traction in 2Q. Assuming a $4.2bn revenue base in 2012, if these new formats could add $600mn in new revenue in 2013 (add 1,500bps to growth), they could have a material impact on revenue trends.

Stifel Nicolaus’s Jordan Rohan, reiterating a Hold rating, writing that there may be support at $16: “If shares reach $16, or a valuation of 10x 2013 EBITDA estimates, we believe the upside would more than compensate for risk due to share sales.”

For the moment, the stock has to contend with the expirations:

Selling by key insiders/VC’s has set a precedent for other sponsors and employees to sell heavily below $20 per share. We believe the period of indigestion may continue as more shares come to market, limiting the positive reaction to growth initiatives.

Although Rohan thinks Facebook as a company is in better shape than its stock, Rohan did trim his estimates. He cut his estimate for the company’s payment revenue by $50 million for next year, lowering his estimate to $6.4 billion from $6.5 billion, and cut his EPS estimate by a penny to 59 cents.


MY VIEW: It’s pretty clear that the investment community and the financial press are squarely focused more on the oncoming overhang from insider lock-up expirations in Oct and Nov, than the near-term fundamentals, which most concede are a tad challenged. (see Pivotal Research report below that details much of the inner-workings of the impending lock-up expiration).

To look at the chart for guidance would be a useless endeavor as there is not support in the stock given its short trading history and the fact the stock trades at all time lows.

So to trade it, you need to get comfortable with the sentiment.  Heading into this past month’s lock-up expiration, most analysts seemed to po-po the overhang.  But following the lock-up expiration, most were left scratching their heads, as insider selling took the stock below $20, including board member Peter Thiel selling most of his stake.

Heading into Oct’s 243 million share unlock, and the 1.1billion share unlock in Nov the shares are likely to remain under pressure, but I would expect the company to attempt to manage this process, possibly through a scheduled secondary offering following their Q3 results expected at or around Oct 25th.  Obviously this is conjecture, but given the size of the overhang, it would make sense for the company to manage this process, possibly even doing another road show (sans Zuck’s hoodie) and get in front of investors and attempt to re-invigorate them.

Make no mistake about it, the analyst community missed the lock-up overhang trade and now may be capitulating a bit, rather than getting their arms around the long-term fundamental prospects of the company.

Calendars set up very well.  I want Sell Nov Calls to Buy Jan Calls. My thought is 2 fold:  first, the overhang will likely keep the stock under wraps until mid Nov, right near expiration, and secondly, the stock is most defintely going to close down a lot on the year, but you could see a sort of “Dog of the Dow” trade as investors position for 2013.

MY TRADE: FB ($18.18) Bought the Nov / Jan13 22 Call Calendar .45

-Sold 1 Nov 22 Call at .62

-Bot 1 Jan13 22 Call for 1.07

Break-Even on Nov Expiration & Trade Rationale:

-If the stock is below 22 my Nov calls will expire worthless and I will own the Jan13 22 calls for.45

-If the stock is at 22 or above I will be up or down the difference btwn Nov that I am short, and Jan that I am long.

-My Max Risk is .45

-If the stock is much lower than current levels, than the Jan calls will obviously be worth less than the premium that I paid for the spread, but at that point I would likely hold them as there is a strong chance that the new year could see irrational price action to the upside…….just as most would not have expected the stock to be down 52% from its IPO price in less than 4 months, with the stock’s 20% short interest (which will only grow), the stock could easily pop back above $20, maybe even to mid $20s once most of the structural bad news is out of the way in Dec/Jan.

-One last point, Nov implied vol is bid higher than Jan by almost 4 points, benefitting the calendar