San Francisco - Facebook may be having trouble connecting with Wall Street.
The financial houses behind Silicon Valley's largest-ever coming-out party kicked off formal coverage of the company on Wednesday by warning about an uncertain business model, margin pressures and a difficult transition to mobile technology.
The reports, released by banks involved in the IPO after a 40-day quiet period expired, represent Wall Street's broadest assessment of the first US company to debut with a market value of more than $100-billion.
Morgan Stanley and other major brokerages that handled the blockbuster IPO said it remained unclear how Facebook plans to make money from a growing number of users logging on to the No. 1 social network via smartphones and tablets. That helped send its shares down three percent.
Of the 17 brokerages that handled the blockbuster IPO and kicked off coverage of the social networking company on Wednesday, eight recommended against buying into the shares. Two of Facebook's three lead underwriters - Goldman Sachs and JP Morgan - were most bullish, targeting Facebook shares at $45 and $42, respectively.
Morgan Stanley, which has come under scrutiny for its role in driving a $38 IPO price that now appears lofty to some, stuck to a price target that matched its debut level and “overweight” recommendation.
The average of target prices cited on Wednesday was $37.64 - a tad below Facebook's stock market debut price.
Facebook's IPO was to have been the culmination of years of breakneck growth for a company that became a social and cultural phenomenon. Instead, it was marred by a series of trading glitches on its debut, and the company and its underwriters subsequently faced accusations of pumping up the price and inadequate disclosure.
Wednesday's panoply of neutral or equivalent ratings is notable because Wall Street research analysts have a reputation for favouring “buy” ratings, particularly in the high-profile Internet industry where “buy” or equivalent recommendations far outnumber “hold” or lower ratings.
The US Internet sector's 110 companies sport a collective 561 “buy” recommendations or better, versus 352 “hold” or “sell” ratings or their equivalent, according to Thomson Reuters StarMine.
“It says there are real questions out there about the strength of this business model, the fundamental strength of this company, together with its valuation,” said Tim Ghriskey, a portfolio manager at Solaris Asset Management.
“We're not buying right now, that's for sure.”
Banks are required to keep their employees handling IPOs apart from analysts recommending stocks in order to avoid conflicts of interest.
In the IPO, banks sold their clients shares of eight-year-old Facebook, started by Mark Zuckerberg in his Harvard dorm room, at a price equivalent to a whopping 100 times 2011 net income per share. That compares with Apple’s current multiple of 20.6 and Google’s 18.9.
“I respect that a Chinese wall exists, but I think it feeds into the cynicism that Main Street has for Wall Street - that one side of the business was telling them to buy at $38 and the other side of the business now at $32 says we shouldn't buy it,” said Steve Birenberg, a portfolio manager at North Lake Capital in Winnetka, Illinois.
Most analysts expect Facebook's large user base to help it corner a substantial share of the Internet advertising market in the long term. But half of the ratings released on Wednesday were “hold” and its equivalent or lower - despite the shares trading sharply down from their $38 IPO price.
Eight slapped top ratings - “buy,” “outperform” or “overweight” - on the social networking company.
BMO Capital Markets' Daniel Salmon began his coverage with an “underperform” recommendation and a $25 target, translating into a nearly 25 percent slide from current levels.
“Slowing user growth is one of our primary concerns for Facebook's current valuation,” said Salmon, the only analyst giving Facebook a negative rating on Wednesday. He estimated Facebook's annual user growth would be 22 percent next year and 16 percent the year after, much slower than expansion in the past.
The 33 banks that participated in the stock listing were required by securities regulations to wait until 40 days after the first day of trading on May 18 before publishing their views, limiting the research on Facebook until now to a handful of analysts.
Scott Devitt at lead underwriter Morgan Stanley, who told the firm's major clients that he had cut his revenue estimates on Facebook just days before the IPO, said he expects Facebook's ability to turn its mobile features into profit to be a challenge for the next several quarters to several years.
He expects revenue to climb 31 percent in 2012, down sharply from the 88 percent growth in 2011.
“No one is debating the potential opportunity in front of Facebook,” said Channing Smith, a portfolio manager at Capital Advisors. “However, there is disagreement in the analyst community on the trajectory of the earnings and revenue growth in the coming years. The assumptions analysts are making are guesswork at this point.” - Reuters