SAN FRANCISCO (Reuters) - Facebook Inc may be having trouble connecting with Wall Street.
Banks behind Facebook’s initial public offering kicked off formal coverage of the social network on Wednesday by warning about its uncertain business model, margin pressures and a difficult transition to mobile technology.
Of 17 brokerages that issued research reports, only eight recommended that investors buy Facebook shares, including Morgan Stanley, Goldman Sachs and JP Morgan - the Internet company’s three lead underwriters. Eight brokerages gave neutral ratings and one had a “sell” rating.
The panoply of neutral or equivalent ratings is notable because Wall Street research analysts have a reputation for favoring “buy” ratings, particularly in the high-profile Internet industry where “buy” or equivalent recommendations outnumber “hold” ratings nearly 2 to 1, according to Thomson Reuters Starmine data.
“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.”
Facebook shares fell 2.6 percent to close at $32.23 on Nasdaq, remaining far below their IPO price of $38.
The reports, released by banks involved in the IPO after a 40-day quiet period expired, represent Wall Street’s broadest assessment of Facebook, the first U.S. company to debut with a market value of more than $100 billion.
Banks are required to keep their employees handling IPOs apart from analysts recommending stocks in order to avoid conflicts of interest.
The average target stock price for Facebook was $37.64, but the range was wide, from $25 to $45.
Morgan Stanley, which has come under scrutiny for its role in driving an IPO price that now appears lofty, set a price target of $38 and “overweight” recommendation. It 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.
“Sell” ratings are rare in stock research, where access to corporate executives is considered crucial.
Facebook’s IPO was to have been the culmination of eight 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.
In the IPO, banks sold their clients shares in the company started by Mark Zuckerberg in his Harvard dorm room, at a price equivalent to a whopping 100 times 2011 net income per share.
Facebook more recently traded around 65 times expected earnings, according to Solaris’ Ghriskey. That compares with Google Inc’s recent price-to-earnings ratio of about 13.
“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.
BMO Capital Markets’ Daniel Salmon began his coverage with an “underperform” recommendation and a $25 target, translating into a nearly 25 percent discount 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 regulators 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, far less than 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.”
Morgan Stanley’s Devitt, BMO’s Salmon and the two lead analysts at JPMorgan and Goldman Sachs covering Facebook have all been near the middle of the pack at stock picking over the past two years, according to Thomson Starmine data ranking analysts’ performance.
Analysts at JP Morgan set a price target of $45 for the stock, suggesting a rise of 36 percent compared with its close of $33.10 on Tuesday.
The company’s stock offering, one of the most highly anticipated in history, was marred by a series of technical glitches at the Nasdaq exchange.
Facebook’s decision to increase the size of the offering by 25 percent just days ahead of the IPO, as well as concerns about decelerating revenue, also weighed on the stock, which traded as low as $25.52 before regaining some ground to trade in a $31-$33 range in recent days.
The rush of research comes ahead of Facebook’s second-quarter results, expected sometime in mid-to-late July.
With about 900 million users, Facebook has become one of the Web’s top destinations, challenging established players such as Google and Yahoo Inc.
Even so, revenue growth from ads and other services is slowing. The company, which last year was more than doubling the amount of money collected every quarter compared with a year earlier, reported growth of 45 percent in the first three months of 2012, and revenue declined from the preceding quarter.
General Motors Co’s announcement a few days before the IPO that it would stop advertising on Facebook has added to the concerns about Facebook’s ability to generate business from advertising.
Despite $4.8 billion in expected revenue in 2012, the average amount of money that Facebook makes through each user is still relatively low, said BofA Merrill Lynch, which expects new advertising formats to accelerate revenue growth in the second half of the year.
In recent weeks, Facebook has unveiled a string of enhancements to its advertising service, allowing marketers to target ads to users on the mobile version of Facebook and to show Facebook users ads based on previous websites that they have visited.
“The company is in the midst of a mobile usage transition and we are cautious on Facebook’s revenue trends until new mobile ad revenue models start driving the top line,” the analysts at BofA Merrill Lynch wrote.
Several analysts working for the underwriters, including Morgan Stanley and Goldman Sachs, cut financial forecasts for Facebook days before the IPO, after the company cautioned about revenue growth due to a rapid shift of users to mobile devices, where Facebook is less effective at generating revenue.
The analysts briefed some institutional clients about their revised forecasts, sources have previously told Reuters, but retail investors were left in the dark. That revelation has resulted in lawsuits alleging the banks and Facebook failed to fully disclose the company’s weakened financial outlook ahead of its IPO.
Additional reporting By Alexei Oreskovic in San Francisco and Tenzin Pema in Bangalore; Editing by Joyjeet Das, Ted Kerr, John Wallace, Matthew Lewis and Richard Chang