Facebook research report released: most analysts are cautiously optimistic

On June 27, 2012, one month after Facebook went public, top Wall Street analysts released their first assessment reports on the performance prospects of the world's largest social networking site, and most of them were cautiously optimistic about Facebook's future growth potential.

Mixed feelings

In more than a dozen research reports released Wednesday, Morgan Stanley and other Facebook IPO underwriters said they are generally bullish on the company's long-term growth potential given its large user base, and most expect Facebook to gain a significant share of the Internet advertising market.

Still, some underwriters said Facebook's business model remained unclear and there were questions about how the company would generate revenue from smartphones and other mobile devices.

Bank of America Merrill Lynch, Barclays Capital, Raymond James, Stifel Nicolaus, Lazard Capital Markets and Citigroup's investment research and analysis units have "hold," "market perform" or equivalent ratings on Facebook shares. Facebook's current share price is about 13% below its IPO price of $38.

Meanwhile, investment banks including Morgan Stanley, JPMorgan Chase, Goldman Sachs, RBC Capital Markets, Piper Jaffray, Oppenheimer & Co and William Blair all rated Facebook's stock as the highest level. Only BMO Capital Markets gave Facebook's stock an initial rating of "underperform" with a target price of $25. "Underperform" is also the company's lowest stock rating.

The most comprehensive assessment

The research reports are the most comprehensive assessments Wall Street has made of Facebook's stock since its IPO in May, when the company was valued at more than $100 billion. Under U.S. securities regulations, the 33 investment banks involved in Facebook's IPO can only publicly publish their views on the stock 40 days after the first day of trading on May 18, so research on Facebook's stock has so far been limited to a handful of analysts.

JPMorgan analysts set a $45 price target for Facebook, which implies a 36% upside potential from Tuesday’s closing price of $33.10. Facebook shares fell 2% to $32.40 in premarket trading Wednesday.

"The next phase of the Internet will be powered by data and ubiquitous network access, and Facebook has an advantage in this phase of the Internet's development, with its large and active user base, effective control over the social graph, and focus on improving the user experience," JPMorgan wrote in the report.

Facebook's debut, one of the most closely watched IPOs in U.S. history, was overshadowed by a series of technical glitches at Nasdaq.

A few days before the official IPO, Facebook decided to increase the size of its stock offering by 25%. Coupled with market concerns about Facebook's declining revenue, Facebook's stock price was under heavy pressure. In the days after the listing, Facebook's stock price once fell to $25.52, but has rebounded in recent days and has been hovering between $31 and $33.

Slowing revenue growth

Goldman Sachs set Facebook's target share price at $42, while RBC Capital Markets set it at $40. Bank of America Merrill Lynch and Morgan Stanley both set Facebook's target share price at $38, while Citigroup and Barclays Capital set it at $35.

Facebook was founded by Mark Zuckerberg in his Harvard dorm room eight years ago. After listing on the Nasdaq, it began trading at 100 times its 2011 net earnings per share. In comparison, Apple and Google's current share prices are 20.6 times and 18.9 times their 2011 net earnings per share, respectively.

Facebook will release its second quarter earnings report in mid- to late July. As a new Internet company, Facebook has about 900 million users, making it one of the websites with the largest number of users in the world, and poses a serious threat to traditional Internet giants such as Google and Yahoo.

Even so, Facebook's revenue growth from advertising and other services is slowing down. Last year, Facebook's revenue growth more than doubled every quarter, but in the first quarter of this year, revenue increased by 45% year-on-year, and the quarter-on-quarter growth even showed a downward trend.

General Motors announced a few days before Facebook's IPO that it would stop advertising on Facebook, a move that has heightened concerns about the prospects of Facebook's advertising business. Bank of America Merrill Lynch said that although Facebook's revenue is expected to reach $4.8 billion this year, the revenue contributed by each user to Facebook is still relatively low.

Challenges during the transition period

Bank of America Merrill Lynch expects Facebook's new advertising model to accelerate its revenue growth in the second half of the year. In recent weeks, Facebook has launched a series of measures to improve its advertising services, allowing businesses to better target ads to users of Facebook's mobile version and showing ads to users based on the websites they have visited before.

"Facebook is in the process of transitioning to mobile, and we remain cautious about Facebook's revenue growth trend unless Facebook's new mobile advertising revenue model begins to drive total revenue growth," Bank of America Merrill Lynch analysts wrote in a report.

Morgan Stanley analyst Scott Devitt lowered his revenue forecast for Facebook a few days before Facebook's IPO. This move also caused great controversy. Devitt said that he expected the profitability of the mobile business to be a challenge for Facebook in the next few quarters or even years. As the lead underwriter of Facebook's IPO, Morgan Stanley gave Facebook stock an "overweight" rating.

In fact, a few days before Facebook's IPO, several analysts from underwriters such as Morgan Stanley and Goldman Sachs lowered their financial expectations for Facebook. The reason was that Facebook was worried that the company's revenue growth would slow down due to the rapid shift of users to mobile devices, and Facebook did not have many effective ways to generate revenue from mobile devices.

According to Reuters, the analysts informed institutional investors of the revised revenue forecasts, but individual investors were kept in the dark. After the incident was exposed, some individual investors sued the banks and Facebook, claiming that they failed to fully disclose the company's true financial expectations before Facebook's IPO.