12 Reasons to Keep Ignoring Facebook’s Friend Request (Part 1)

Submitted by Wall St. Daily using our Trefis Contributor Tool

On the heels of a disappointing earnings report – and the end of the first lock-up period – Facebook’s (Nasdaq: FB) stock keeps dropping. Shares hit an all-time low of $18.75 on Monday, marking a 50% drop from the IPO price of $38.

While other investors cringe as their losses mount, I’m rejoicing. As you well know, I questioned Facebook’s investment merit way before it ever went public (see here). I even recommended that WSD Insiders sell the stock short in early June. And now they’re sitting on a 26% profit.

So, is it time to cash in and move on to a new opportunity? Not a chance. I’m still convinced Facebook holds significant profit potential. That is, if you sell the stock short.

And here are 12 reasons why…

1. You Can’t Take Potential to the Bank

Wall Street analysts must be rocking out to DJ Jazzy Jeff and The Fresh Prince’s 1989 youth anthem, “Parents Just Don’t Understand.” Because report after report keeps bemoaning that investors just don’t understand… Facebook has potential!

• Ken Sena at Evercore Partners values Facebook at $34 per share, based on its long-term potential to unlock the trove of data it has on its roughly one billion users. (Source: Yahoo! Finance)
• Bernstein Research analyst, Carlos Kirjner, upgraded Facebook to “Market Perform.” In doing so, he said the company’s potential around its innovative social graph was worth a $4 premium. (Source: Reuters)
• Rory Maher, analyst at Capstone Investments, raised his rating on Facebook to a “Buy” Monday, citing “potential returns from new businesses the stock price currently does not give the company credit for.” (Source: The Wall Street Journal)

Now, parents might not understand. But they’re still in charge. So are investors when it comes to Facebook’s stock. And right now, they’re not buying into Wall Street’s hype.

Or, as Jeff Macke wrote for Yahoo! Finance, “Hoping Facebook figures out how to gather more than $4 per user in revenue per year isn’t an investment thesis.”

No it’s not! When Facebook fails to live up to Wall Street’s high hopes, look out below.

2. Peer Pressure Never Pays

Speaking of high hopes, 36 analysts currently cover the stock. Yet only two have a big enough pair to rate it a “Sell.”

What’s worse, the average price target checks-in at $35.90. That’s about 80% above current prices, which reeks of being completely out of touch with reality.

I get that many of these analysts work for banks that served as underwriters. But even if we disregard their inherent bias, the ratings and price targets are completely lopsided. And as Humphrey B. Neill said, “When everybody thinks alike, everyone is likely to be wrong.”

3. What “Other Opportunities” Could Possibly Compete?

Since Facebook’s IPO, five high-profile executives left to pursue other opportunities: Director of Platform Partnerships, Ethan Beard; Director of Platform Marketing, Katie Mitic; Mobile Platform Marketing Manager, Jonathan Matus; Chief Technology Officer, Bret Taylor; and Open Graph Product Manager, Carl Sjogreen.

Can Facebook’s future really be that bright if employees are jumping ship?

4. First in, First Out

Forget about management. Let’s focus on investors. If Facebook’s future was so bright – a la Google’s (Nasdaq: GOOG) outlook shortly after it went public – early investors should want to hang tight, right? Well, they’re not.

According to SEC filings, Peter Thiel, Co-Founder of PayPal and one of Facebook’s earliest investors, cashed out almost all of his remaining shares on August 16 and 17 for $395.8 million.

Venture capital firm, Accel Partners, joins him. On August 16, it distributed more than 50 million shares to investors in its funds to liquidate.

Could these sales be part of a tax arbitrage strategy to avoid higher tax rates in 2012? Possibly. But you usually wouldn’t worry about capping your taxes unless you fear your future gains are muted. Just saying.

5. Fool Me Once, Twice, But Not Thrice?

Other big institutional investors are undoubtedly eyeing the exits, too. Why? Because Facebook marks their third black eye in the last year.

Big investors in Facebook, like Fidelity and T. Rowe Price, were also early investors in Zynga (Nasdaq: ZNGA) and Groupon (Nasdaq: GRPN). And we all know how those investments panned out. Terribly.

Selling Facebook before it flops to Zynga- or Groupon-esque levels could represent the only opportunity to save some face.

6. Get Out While You Still Can

The selling pressure isn’t about to let up, either. Last week marked the first lock-up expiration of many between now and the end of the year.

Based on the following list of lock-up expirations, November looms large for a mass exodus:

• 243 millions shares (unspecified date between October 15 and November 13)
• 1.22 billion shares (November 14)
• 149 million shares (December 14)

Like I said when I originally told WSD Insiders to sell Facebook short, “If a bird in the hand is worth two in the bush, it’s safe to assume many Facebook employees [and other shareholders] are dying to unload shares at the first opportunity they get.” Given the stock’s sharp decline thus far, I’m convinced that statement rings even truer now.

Stay tuned for tomorrow’s column where I’ll share the remaining six reasons to sell short Facebook. That includes the most important reason of all. Namely, that Facebook remains dramatically overpriced relative to comparable high-growth internet companies. I’ll tell you how overpriced it is, too.