Did Facebook’s Zuckers Miss These Crucial Caution Signs?

The Facebook (NASDAQ:FB) retail stock timeline is less than a week old, yet it is already filled with disastrous stories. Shares of the world’s largest social-media company debuted on the Nasdaq (NASDAQ:QQQ) last Friday and hit as high as $45 before closing at $38.23, just 23 cents above its initial public offering. On Tuesday, shares fell to as low as $30.98, representing a 31 percent decline from its high to low. While the Facebook story is far from over, there were plenty of warning signs to the stock’s rough start.

Some may be quick to point out that since Facebook does not offer a real tangible product like an Apple Inc. (NASDAQ:AAPL), it was doomed from the start. However, the successful IPO of LinkedIn Corp. (NYSE:LNKD), which currently trades at more than double its IPO price, quickly dispels that theory. Instead, the loudest warning shot came straight from the horse’s mouth, Mark Zuckerberg.

In a February S-1 filing with the Securities and Exchange Commission, the young founder and chief executive officer sent a message to investors that “Facebook was not originally created to be a company. It was built to accomplish a social mission, to make the world more open and connected.” The SEC filing included a personal letter from Zuckerberg and painted a clear picture that Facebook is out to change the world and shareholders are simply along for the ride. He says, “As I said above, Facebook was not originally founded to be a company. We’ve always cared primarily about our social mission, the services we’re building and the people who use them. This is a different approach for a public company to take.” He goes on to break it down as simple as possible by stating, “Simply put: we don’t build services to make money; we make money to build better services.”

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The letter even goes against one of the first lessons that business students learn in Finance 101 about maximizing profits. Zuckerberg explains, “These days I think more and more people want to use services from companies that believe in something beyond simply maximizing profits. He continues, “We don’t wake up in the morning with the primary goal of making money, but we understand that the best way to achieve our mission is to build a strong and valuable company. We’re going public for our employees and our investors. We made a commitment to them when we gave them equity that we’d work hard to make it worth a lot and make it liquid, and this IPO is fulfilling our commitment.” Zuckerberg goes on to explain that as Facebook (NASDAQ:FB) transforms into a public company, it will make a similar commitment to new investors, but obviously with shares trading near $31, that commitment is still in the “it’s complicated” phase.

Ignoring the groundbreaking social aspects of Facebook and the potential of monetizing data on 900 million users, warning signs also poked through in the financial numbers released in an April S-1 filing. The document showed that total revenue for Facebook declined to $1.058 billion in the March quarter, compared to $1.131 billion in the December quarter. The decline in revenue also occurred as Facebook ramped up marketing and sales expenses 20 percent to $159 million in the quarter. Total costs and expenses increased almost 14 percent to $677 million, compared to $583 million in the December quarter. When an IPO places a value of $104 billion on a company, investors should be looking for outstanding fundamentals or at least an extensive plan for future growth. Unfortunately, Facebook is lacking in both departments.

To make matters worse, Reuters recently reported that shortly before Facebook’s IPO, Morgan Stanley (NYSE:MS) told its big clients that the bank’s consumer Internet analyst, Scott Devitt, was significantly reducing his revenue forecasts for the social network. “This was done during the roadshow – I’ve never seen that before in 10 years,” a source at a mutual fund firm among those called by Morgan Stanley told Reuters. Morgan Stanley was the lead underwriter in the Facebook deal and the fact that its own analyst had doubts and would make such a move prior to the IPO violates our ‘S= Support is Provided by Institutional Investors & Company Insiders’ in our CHEAT SHEET investing framework.

As the saying goes, hindsight is 20/20. While it is easy to look back and see why a stock performed poorly, perhaps if more retail investors conducted their due diligence before jumping into stocks, fewer would be burned on over-hyped initial public offerings.

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