Facebook IPO: Dollars and Sense

Facebook’s IPO is scheduled to hit the market Friday. It has been a long time coming; the Palo Alto based tech social networking site has eluded Wall Street much longer than tech startups are supposed to.

 

Now it seems the only reason that they’re taking this step is because they’ve grown too big to keep their financial information private and no longer enjoy the most important benefit of being privately held. While other tech startups are starving for capital, Facebook shunned investors even as they grew to become the most visited website in the world.

 

“Do You Have a MySpace page?”

 Only a few years ago MySpace was the most ubiquitous social network. It seemed like everyone was on MySpace, and most people my age were. I still remember the first time I heard someone answer no to that question. A friend had returned home from college, and instead of a MySpace page, he said he was on Facebook.

 

I was intrigued not only because I had never heard of Facebook, but because he seemed to not care that he wasn’t available on the largest social networking application available at the time. I made him show me the website, but was unable to join because the technical college I attended wasn’t listed in Facebook’s drop down menu, and you needed a student address to access the website.

 

Facebook was unlike every other startup that was on the Internet. Mark Zuckerberg was unlike any other business man. Instead of targeting a wide audience – because after all, generic social networks usually aren’t associated with exclusivity – they opened their doors to small groups at a time. With each new university, and then each new demographic, Facebook made impressions on those who weren’t able to access the network.

 

It was a perfect storm, and no one can deny that. If an AARP membership was required to join the first version of Facebook instead of a student e-mail address, we would be talking about MySpace today. The key to the site’s success was purely luck. Workaholic thirty-something’s have a fond remembrance of college, and high school seniors look forward to it with wide eyes.

 

By entering the marketplace with the college demographic, Facebook was guaranteed to reach the siblings and the parents of every undergrad that made an account. When compared to MySpace pages that allowed users to post everything from full length movies to the latest NOW music compilation (in its entirety), Facebook’s simple and utilitarian design had mass appeal. My friend had no intention of making a MySpace page that day, but I was ready to trade mine in.

 

The Business End

I have been trading stock daily since I turned 22, almost 5 years ago. Right now there are a lot of numbers flying around regarding Facebook’s valuation, and it was brought to my attention earlier that most people who follow social media have no idea what it means.

 

The overall valuation for the company is approximately $100 billion. This week Facebook will release their Initial Public Offering to a primary market of buyers that have been working on their deal since the IPO was announced. Almost immediately shares will start appearing on the secondary market.

 

Many of Facebook’s current stakeholders will be itching to cash in on some of the shares they own, and there will be plenty of speculators trying to make quick profits on the shares they can get their hands on. The price for a share of Facebook stock in the IPO is projected to go for between 28$ and 35$. After the shares hit the secondary market, all bets are off.

 

There is a ton of risk associated with investing in Facebook stock. First and foremost, the stock is extremely overvalued at its current price. Even for a technology company with substantial growth prospects, the price to earnings ratio (P/E) and price to value ratio is higher than anything comparable.

 

Facebook’s revenue grew by 88 percent last year, and if they can sustain that growth it will be a bargain in a few years. They won’t though, so if all of the numbers say that buying Facebook stock this week is a bad deal and there is so much risk involved, why is it such a big deal – and why are investment firms reporting that they’ve already sold their reserved blocks?

 

The answer goes to the basis of how stock is valued in the first place: supply and demand, relative value, and mob mentality. Facebook stock isn’t just worth a pro ration of what last year’s profits were. It’s only worth the value that you put on it. If you think it should be worth 100$ per share and are willing to pay that, then it’s worth 100$.

 

There are thousands of analysts, investors and finance experts who after considering all things, still believe that Facebook is one of the most promising companies in the tech industry and are willing to bet millions. On top of that, there are hundreds of thousands of untrained and uneducated people that know Facebook is more popular than Google and since Google’s stock sells for several hundred dollars per share, Facebook stock should be worth way more than that. Finally, there are thousands more speculative investors who are counting on high trading volumes spurred by uneducated investors hitting up their E-trade accounts and massive purchases from institutions to skyrocket the stock’s price during the initial frenzy.

 

This Friday, assuming everything goes as planned with the release of the IPO, Facebook will mint several hundred millionaires, and thousands of investors will purchase shares hoping to parlay their savings into major cash over the long term. There is a good chance that the stock price could surge to double its price before the end of trading Friday. I’ve saw several smaller IPOs surge from 12$ per share to nearly 90$ per share in their first day on the market. Of course that was during the dot com bubble, but the frenzy still wasn’t this thick. Then again, there could be some major losses.

 

Facebook has taken over the Internet doing what it knows how to do: building on its social network. With only a billion users, the current valuation puts the value of each of those customers at about 100$ a piece. The real value comes in the form of user information that can be leveraged by advertisers, and also used for future product development. What many people don’t realize is that the Facebook like widgets that you see on basically every single website also collects data, making Facebook’s data network one of the most far reaching networks on the Internet.

 

The company has reached a level where it is possible to compete in search with Google, compete in online shopping with Amazon, and even create their own third party ad network fueled by the user information collected from Facebook. The Internet is Facebook’s playground and they haven’t even begun to expand. Through horizontal integration and leveraging the power of the Facebook name and platform, the sky is truly the limit. We may look back and count ourselves lucky to get in on Facebook when it was still just a social network.

 

Don’t Get Zuckerberged

The pendulum can swing both ways when it comes to Facebook’s initial public offering. Facebook is known as an addiction just as much as it’s known as a means for communication. With privacy concerns, interface changes, hackers managing to flood your stream with porn, bots and spammers, copyright infringement, stiff competition, patent agreements, user sentiment, the fact that Facebook is just now concentrating on the business end and Mark Zuckerberg himself, it’s a surprise that Facebook has managed to stay on top this long.

 

Everyone agrees that Facebook’s primary lure is the fact that all their friends and family are there. The truth is that the average user is only active on the site for less than a half hour each day. Even though this propels the network’s usage rating sky high in the online world, it’s hardly enough time to allow the average user to get disenfranchised by their experience.

 

There just isn’t a huge threat of 1/6 the world’s population feeling the need to quit Facebook and finding a viable alternative anytime soon. With that kind of scale, it’s too easy for Facebook to intervene with corrective measures. If Facebook’s fortunes were reversed tomorrow, it would take several years for enough users to leave to make a noticeable dent in most user networks.

 

Even though Facebook is a behemoth and most pundits agree that they aren’t going anywhere anytime soon, not everyone is in love with Facebook. They certainly don’t have the brand advocacy of Apple, and there is a lot of negative press directed at the site. Everything from obesity, depression, stalking, property crime, lewdness, harassment, threats, fraud, biological implications, decreased sex drive, infidelity, stress, and sometimes crimes such as murder have been associated with the site.

 

In the UK, more than 100,000 crimes have been linked to Facebook. Just last week a teenager in my region was incarcerated after he posted a picture of himself stealing gas from a police cruiser on Facebook. 1 in 5 Divorces are blamed on Facebook, and the social network is often a topic of argument for couples. Most users have admitted to despising the thought of Facebook since they signed up, and plenty have opted out of their account. Statistics show that most of those users return, and since they’re leaving one at a time, there is never any real threat of a mass exodus.

 

The point is that the majority of users see sociological problems with Facebook, and everyone has a negative story to tell about it. The ability to withstand so much bad press is an achievement itself, but the common negative perception has always been a liability.

 

Facebook Can Fail While Still Growing

The latest business move Facebook made was its acquisition of the popular mobile application Instagram. Facebook negotiated a deal worth $1 billion (the majority of which is thought to be in Facebook stock) for the burgeoning social photo sharing app. The deal still has plenty of red tape to navigate, but unless the government finds a problem, it’s all but done.

 

Most experts agree that Facebook has weak mobile prospects, and the acquisition of Instagram was a move in the right direction. Their main problem is that most of their revenue comes from displaying ads to users. When users access Facebook via mobile device, those ads are not displayed. It’s a major hole in Facebook’s business model, especially considering the proliferation of users accessing social networks through their mobile phone or other handheld device.

 

Facebook even listed this as one of their weaknesses in their SEC filing. Since mobile use is growing, their revenues will shrink regardless of a growing user base. Of course there are ways to monetize mobile traffic, but it isn’t as valuable as browser based traffic, and there are lots of reasons to avoid placing advertisements in the Facebook mobile app if at all possible.

 

The mobile problem is the most visible weakness, but the nature of social networking and the Internet makes Facebook’s business very vulnerable regardless. I didn’t think that I’d be using Facebook because MySpace would become dormant back in 2007. Neither did Fox Newscorp, who bought MySpace for a hefty sum only to sell it for pennies on the dollar a couple years later.

 

The Internet is still the wild-west, and the relative structure brought on by social networking sites like Facebook themselves isn’t hard to see past. Technologies have fell like dominoes since the Internet’s inception, so the main question is how will Facebook be any different?

 

My advice as an informed investor who has saw this type of thing before (well, almost. Nothing exactly like this has ever happened) is to wait it out. Don’t rush in to buy shares on the secondary market. Let the dust settle and figure out what you want to do after the price corrects itself. 

 

If Facebook’s current shareholders decide to liquidate their holdings and cash in the price could fall sharply. Remember that these are young people who have been paid in promises for years. What’s the difference between having $200 million today and having $240 million next year? There isn’t any good reason for a lot of these shareholders to hold their stake and risk becoming the last person with a MySpace account. However, as an adventurous day trader I’ll probably set a limit order and pick up 50 shares of FB as soon as my Sharebuilder account can execute a trade.

 

Do you plan on investing in Facebook stock? How well do you see the company doing in the short and long term, and what is your sentiment for the network itself?