1 Ominous Sign for Facebook No One's Talking About

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Shares of social-network titan Facebook (Nasdaq: FB  ) have taken a severe beating since their May 18 IPO. Since then, shares have fallen more than 40%, in part because of a disappointing quarterly earnings report June 26. But Facebook's not done with its fall yet. I think we'll see shares continue to lose value thanks to two little but expensive words: lockup period.

Watch the lockup period
The lockup period, a period of time post-IPO when owners can't sell their shares, usually lasts 90 days.

But Facebook has a staggered, two-date lockup period, one ending on Aug. 15 (90 days post-IPO), and another on Nov. 13. On these two dates, 268 million and 1.24 billion shares, respectively, will be available for sale. For a company with 2.14 billion shares outstanding, this poses a very real threat of flooding the market.

Of course, just because insiders can sell, doesn't mean they will, especially given the downward trajectory of the stock recently. But if we take a look at some similar dot-com stocks like LinkedIn (NYSE: LNKD  ) , Zillow, and Pandora, we see that the market does become a bit overwhelmed with sell orders. Their shares traded an average of 3% lower just a week after the lockup expiration ended.

A 3% drop doesn't exactly amount to a massive sell-off, but it's still no good for investors. And while the longer-term relationship between the end of lockup periods and share performance isn't conclusive, you can bet there's more than one Facebook paper millionaire waiting to become a real one.

Not everything about social media stinks
Not everything about Facebook screams "overvalued!" As Foolish commentator Rick Munarriz pointed out in a recent piece, it has some undeniably attractive aspects to its business. The company has nearly a billion users and growing, it has a lot of cash, and it's working proactively to put itself in the right areas for long-term staying power.

As long as we're talking social Internet companies, LinkedIn looks like the better choice -- although I still wouldn't touch it from the safety of a fire-resistant hazmat suit with a 10-foot pole.

Instead of relying almost entirely upon advertising for revenues as Facebook does (85% of 2011 revenues were from advertising -- yikes!), LinkedIn makes an increasing proportion of its money from "hiring solutions" -- a service with wild demand in the current economy. So LinkedIn, the "professional social network," will naturally focus on a smaller but more affluent market segment. In Q1, LinkedIn reported year-over-year member growth of 58% -- twice the growth of Facebook membership -- and had 160 million members.

On top of that, LinkedIn announced that it will be integrated into future versions of Microsoft Office, which will instantly familiarize millions of users with LinkedIn's interface, adding a lot of value to LinkedIn's business.

All the same, I would still stay away from its stock. A P/E 40 times higher than the industry average and a price-to-sales ratio four times higher than industry averages simply aren't justifiable for a company in an industry with insanely low barriers to entry. By no means is LinkedIn a buy, but when it's all said and done, it's still a better buy than Facebook.

Too many questions, not enough answers
At the end of the day, there are just too many uncertainties in Facebook's future for me to be comfortable putting my money into it as a rational investor. When the CEO shows up to the quarterly conference call and it's lauded as a bullish indicator, as is having the stock hitting a new all-time low, you can count me 100% out.

In fact, I've rated both Facebook and LinkedIn as "underperform" on my CAPS page. If I could I'd rate them both "super double underperform," but unfortunately that's not allowed.

Facebook and LinkedIn are already extremely well-known, widely used services. The time for investors to make massive returns in a short period of time has come and gone (or has yet to arrive for one of these two companies). But if you're interested in reading about the longer-term Facebook play, you can pick up a copy of the Fool's new premium research report on Facebook.

Fool contributor John Divine owns none of the stocks mentioned in the story above. He kind of hopes Facebook starts charging users soon, though, so that he'll stop using it. You can follow him on Twitter, @divinebizkid, and on Motley Fool CAPS, @TMFDivine.

The Motley Fool owns shares of Facebook and LinkedIn. Motley Fool newsletter services have recommended buying shares of LinkedIn and Facebook. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 02, 2012, at 12:20 PM, Brent2223 wrote:

    I look forward to the pumping that will be coming in Oct/Nov, then some insider dumping, followed by a nice brain drain of facebook insiders, and a flurry of startup social sites by ex-Facebook staff, who will inevitably create something that has the cool buzz that facebook had in its early days.

    Popularity is a double edged sword with social media - sure more users is great, but they definitely lose most of their cool factor when users need to start worrying about Grandma checking up on them.

    Let's also see what happens when the facebook generation starts entering the workforce and realizes having a complete photo history of all their youthful indiscretions online may not be such a good thing (when Facebook gets desperate just watch to see how they try to monetize all the personal info they're holding...)

    Business social media is a completely different beast - the bigger linkedin gets the better and more valuable it is for all users.

    Look at source of revenue. Linkedin users probably don't mind having employers on their trying to hire them, so signing up more employers and growing revenue is good. Show me one facebook user that says 'if only there was a bit more advertising on the site...'

  • Report this Comment On August 02, 2012, at 12:38 PM, XMFDivine wrote:

    @Brent2223, Good point about the Grandma factor and the highly blackmailable (if I may invent a word) Facebook generation. I have a feeling there will be more than enough regret to go around for the content people have voluntarily posted on social media sites.

    And you're right about LinkedIn. Its model has much more long-term utility, I think, since people will always want to either get a new job or test the waters for whats out there. Right now, I just can't get to its valuation from an investment standpoint. But it's a well-run, solid company, no doubt about that.

  • Report this Comment On August 02, 2012, at 1:33 PM, TheRealRacc wrote:

    Can someone explain what it means to have "1 billion users and growing"?

    2.3 billion people have Internet access. This isn't like McDonalds where one customer can provide a significant amount of individual revenue over the course of a lifetime. It makes a lot of sense to read "1 billion customers served and growing", but "1 billion users and growing" has a certain contradiction built in. I just don't see what we have to look forward to with Facebook that I can't get better, elsewhere.

  • Report this Comment On August 02, 2012, at 3:29 PM, BiggJilm wrote:

    I love facebook and bought the stock. I was caught up by all the hype that went along with the IPO. I quickly sold for a loss and don't look to get back in until much later after the lockup. Great write up!

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