Facebook’s shares are down 6% in the pre-market this morning (they were down as much as 10% last night) following Q3 results that were better than expected. The cause of the initial decline is the forward guidance given that did not excite plus the registration of 180 million shares rewarded to the founders and investors of the recently closed $22 billion WhatsApp acquisition. While we were not inclined to take a position prior to the report, we were fairly skeptical of the company’s ability to match very high expectations with the stock just below all time highs, up some 47% on the year. Heading into the print, FB sported a market cap of $209 billion on an expected $12 billion of sales in 2014. In most any other period in history, excluding of course the late 1990s, this sort of valuation would be deemed to be pure fantasy.
The stock was priced to perfection into last night’s print, and that is the cause for this morning’s weakness, but while the stock is down, it is surely not out, yet.
Think about it this way – FB’s stock had gained an astonishing $80 billion in market cap in 2014, as investors bought into tens of billions of dollars in acquisitions, matched with continued rapid mobile adoption, and the subsequent selling of ads on existing and new platforms. All makes sense in the right market as long as investors feel that forward guidance is conservative and that spending won’t go through the roof, thus suppressing profits.
Is it still the right market? It’s important to note that momentum has been waning in the large cap internet space for weeks, with very few making new highs with the S&P500 on Sept 19th, which was also curiously the first day of trading for Alibaba. Since then, every large cap internet stock that has reported their Q3 results (aside from Yahoo) has declined in the day following their print:
AMZN -8.3% on 10/23/14
EBAY -4.7% on 10/15/14
GOOGL -2.6% on 10/16/14
NFLX -19.3% on 10/15/14
P -13.5% on 10/23/14
TWTR -9.8% on 10/28/14
YELP -18.6% on 10/22/14
You get the point. It’s been a total shit-show for net stocks, and I would add that all of the above are down on the year except for NFLX. NFLX is up 5% year-to-date, but still down 20% from the recently made all time highs.
SO what exactly has happened here?? Well, what’s fairly obvious is that there has been a changing of guard in the internet sector. The majority of the stocks in the sector have been for sale, possibly to make room for two of the largest names – pure play mega cap social media in terms of FB and the new kid on the e-commerce block BABA. Everything else, including GOOGL to some degree, has been shoot first, ask questions later.
Which is why FB’s reaction to last night’s weaker than expected guidance could hold one of the keys to the health of the rally in tech shares in my opinion. I would also add that BABA is a total outlier given its limited trading history. BABA’s performance after its own results, due before the open on Nov. 4th, could thus offer potential downside to broad market sentiment.
As for Facebook itself, the lockup overhang is a major issue. FB’s IPO was $16 billion, for which it took months to find buyers at the appropriate price. The shares for sale on the WhatsApp lockup expiration total about $13 billion in value, a very significant sum even for a $200 billion market cap company like FB. Until that supply is cleared, FB’s upside is likely to be limited, with this week’s high of $81.16 likely providing stout resistance.
There was little wrong with the report and guidance, merely a matter of expectations. BUT, those expectations are based on an alternate reality in current equity valuations.