FXstreet

The praise from Wall Street was effusive in the wake of Facebook’s second-quarter earnings report July 23, rushing to boost ratings and raise price targets. The table tilted slightly back the other way Wednesday morning, when analysts at Janney Capital Markets dropped their rating from buy to neutral, warning that investors may not be willing to pay such rich prices for the social network in 2015 and beyond.

Janney’s Tony Wible is quick to acknowledge the company’s “amazing” monetization” potential, from existing revenue streams like the core mobile advertising business, to the future of Instagram and potential new products. But Wible thinks the current price and valuation of the stock already reflects those developments, prompting the downgrade.

“[E]xpectations are catching up and could trigger valuation compression,” Wible writes in a note to clients, pointing to the diminishing returns for big earnings beats. After surging 30% when it beat earnings per share estimates in the second quarter of 2013, Facebook gained just 5% for a 31% upside beat in its latest quarter.

“We suspect this is tied to very bullish sentiment (86% of the Street has a ‘Buy’ rating) and investors continually expecting FB to beat numbers heading into earnings,” says Wible. The more modest reaction the latest earnings beat “suggests compression is starting to settle in.

None of this is to suggest that Facebook is in danger of having its multiple crushed. The company currently fetches a forward price-to-earnings ratio of almost 47, and goes for 83 times trailing 12 months earnings and 20 times sales.

Facebook should get a premium to its peers, Wible figures, but he still expects its forward-sales multiple (using 2016 sales forecasts) to drop to 10.5 from 12.5, leading to an $84 price target, still offering upside from Wednesday morning’s $75.03 level.

If Facebook’s sales growth decelerates heading toward 2016, which is likely as the recent growth surge makes future comps more challenging, Wible says the post-IPO experience of Google may be instructive as a corrolary.

“[Google] sustianed a relatively consistent price-to-sales-growth for the first 5 years post-IPO,” Wible writes. “The constant multiple appeared to weigh on the stock as growth decelerated [in 2006],” leading to a stock that spent much of that year struggling to retake the $200 level for much of the year (see chart) “despite upward revisions to a decelerating out-year growth rate.”



Facebook has yet to show any signs that growth is slowing — revenue was up 60.5% from the prior year in Q2, compared with a 53% increase in the corresponding period of 2013 — but by the time it does, Wible seems to think, the valuation will have already regressed. He does acknowledge though, that investors haven’t quite priced in everything.

“We believe investors are underestimating the potential for a payment product that can trump the potential size of other well known opportunities,” Wible writes. That rollout will be gradual though, so he isn’t quite ready to build the “payment wildcard” into his current forecast.

Shares of Facebook were down 1.5% to $74.86 Wednesday, but are up nearly 38% in 2014.






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