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The Facebook Analyst Downgrade

Jon C. Ogg

Facebook Inc. (FB) did manage to surprise not just Wall Street and Main Street with its earnings report. It blew the numbers out of the water, and CEO Mark Zuckerberg is even proving to deliver on his ambitions to capitalize off of the ongoing and inevitable move of users to mobile away from desktops. Many analysts raised their price targets and estimates on Thursday after the report, but the independent research firm Argus came out and downgraded Facebook's stock to Hold from Buy in call that was outside of the Wall Street pack.

24/7 Wall St. wanted to dig into this call to see if Facebook investors should take their profits now or if they should consider staying on this ride. Joseph Bonner of Argus pointed out that the main reason for cutting the rating to Hold is valuation after the big run-up in the stock price.

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From the report:

Facebook shares rose nearly 30% intraday on July 25 after the company reported strong 2Q results, lifting the stock to the high end of our target valuation range. We prefer to exercise discipline by downgrading the shares rather than jumping on the momentum bandwagon. Our rating change is also based on management’s clearly delivered color on the second-quarter call. We think that Facebook is just beginning to reap the returns on its investments in mobile and new and targeted advertising products. Nevertheless, we expect its results to be highly variable in the coming quarters.

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That being said, Argus raised its 2013 EPS estimate to $0.63 from $0.51, and the estimate for 2014 went up to $0.81 from $0.69 per share. Also note that Argus is expecting that Facebook will get aggressive on its capital spending. But do not expect a dividend any time soon. The firm said, "We expect the company to resume aggressive investments in 2013, so free cash flow will likely be volatile. Facebook does not intend to pay a dividend in the near term."

On the valuation front, Bonner points out that Facebook's stock price still trades 10% below its IPO price, and its enterprise-value/EBITDA multiple of 26 is well above the peer group median of 16.5. His two-stage discounted cash flow model points to a valuation range in the high $20s to mid-$30s, so the valuation downgrade based on a $34.36 share price was made.

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Trading in Friday's morning session has the stock down 1.3% at $33.90, but we would be fast to point out that a gain of almost 30% followed by only a 1.3% drop in profit taking is so small that it is insignificant for now.

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