Why Facebook Was Downgraded

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Facebook Inc. (NASDAQ: F) was downgraded to Hold from Buy at Argus on Monday. The call is not all that bad on the surface, and Argus even maintained its a Buy rating on its long-term outlook with a $73 price target. Monday’s downgrade said that the $67.72 share price was approaching the firm’s former target price of $73.

Argus did say that CEO Mark Zuckerberg has clearly laid out Facebook’s plan to build the WhatsApp user base to a billion, rather than focusing on monetization through the upselling of premium services. This comes with a risk:

If those billion users fail to materialize, Facebook would be looking at a substantial write-down, a clear negative for Facebook shares. We will be paying close attention to WhatsApp’s net user addition data in the face of competitive threats.

No significant earnings estimate changes were made. Argus maintained its 2014 earnings per share estimate of $1.21 and its 2015 forecast of $1.53 per share. Still, Argus referred to the WhatsApp buyout price as eye-popping. The firm believes that there is great strong long-term potential, which is why its five-year rating remains Buy.

Argus also admitted that its downgrade could prove premature if new forms of advertising (including mobile video) on the flagship Facebook site accelerate average revenue per user and drive stronger results. The severe rally in shares over the past year has also boosted valuation, which is the real impetus for Monday’s downgrade.

Security flaw concerns in WhatsApp were also brought up, although they were somewhat minimized. Argus further said:

Mr. Zuckerberg gave a keynote address at the Mobile World Congress in Barcelona on February 24. Most of the discussion concerned internet.org, an industry alliance that aims to connect all (or most) of the people in the world to the internet. The idea here is to provide free or nearly free text-based basic services such as messaging (think WhatsApp), Facebook, basic search, and Wikipedia, among others, which Mr. Zuckerberg views as an “on ramp to the internet.” While this is laudable concept, the relevant business models are hazy at best. Still, Mr. Zuckerberg is taking his role as an internet visionary quite seriously.

So far the downgrade is being discounted with an early market rally on Monday. Facebook shares were indicated up more than $0.40 at $68.15 right at the open.

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