Thursday, 2 February 2012

Is Facebook IPO Over-Hyped ?

With everyone having at least one account on Facebook :) we all know about the Facebook IPO, Facebook offcourse generated some buzz in the investing world with news that it underwent a restructuring. Facebook stock was redone so that there are now two classes of Facebook stock. One class of Facebook shares has much more voting power than the other class of Facebook stock shares. This structure is similar in design to Google stock structure in which one class of Google shares has controlling voting rights interest while the publicly traded Google stock has almost no say in how the company is run. The question is, if the company goes public with a Facebook IPO should investors buy Facebook stock, and are Facebook shares a good investment?

Most companies explore going public when they generate about $100 million in annual revenue. Facebook is on track to amass over $4 billion in revenue in 2011. Given this fact and the company’s expected valuation, the size of Facebook’s IPO is not surprising.
Some facts about Facebook’s anticipated $10 billion IPO:
  • Largest internet or technology IPO globally EVER
  • 4th largest IPO by a U.S. company
  • 13th largest IPO globally
As a point of comparison, a $10 billion Facebook IPO would be over seven times as large as Google’s $1.4 billion IPO in 2004. If the Google IPO frenzy is any indication, Facebook’s IPO should generate near-hysteria among Wall Street and some investors. Facebook’s IPO date is expected to be in the April-June 2012 time frame, though there is some buzz that it could occur earlier.  The price (or price range) of stock shares is set when a company registers its IPO, so the price is not yet established.
Consider how many of Facebook's users do absolutely nothing on the website other than share pictures and updates with their family members. How many grandmas log onto Facebook daily for no reason other than to see if pictures of their grandkids have been posted by their children? These users not only never click on an ad, they don't pay any attention to them either, because they have never made an online purchase in their life, making their "eyeballs" worth less than on other websites. 

Facebook’s Financials

Facebook isn’t required to make its financial results public (It will be required to do so by April, because it will cross the 500-shareholder limit by the end of this year). However, there are good estimates available.


Facebook will generate revenue of $4.27 billion this year, according to Bloomberg, citing data from research firm eMarketer. Approximately $3.8 billion, or 89% of total revenue, will come from advertising. The other 11% comes from other sources, most notably gaming developed by its partner, Zynga, the creator of Farmville. Ad revenue growth is up 104% from $1.86 billion in 2010. For 2011, Facebook will have about a 16.3% share of U.S. internet display ad revenue, and that number is expected to grow to 19.5% in 2012.
FB generated about $1.6 billion in revenue in the first half of 2011, while its operating income and net profit margin were reportedly $800 million and $500 million, respectively. Thus, operating and net income percentages were about 50 and 31, respectively. These are SOLID profitability numbers. How do these numbers stack up against some heavyweights like Apple and Google?
A company’s profitability is best compared to others within the same industry, but Facebook has no direct peers that are public companies (Twitter is a private company) other than LinkedIn (to some degree), and LinkedIn has only recently gone public. 

So Facebook Stock Looks Like a Great Investment, Right?

Hold on! While Facebook’s operating and profit margins above look good compared to Apple’s and Google’s, it’s important to keep two major factors in mind:
Valuations. Apple’s stock is trading at a P/E (price-to-earnings) ratio of 14 and Google’s at a P/E of 21. These stocks are reasonably priced given their growth rates (54% and 26% quarterly earnings growth, respectively). The price for a share of FB stock won’t be determined until the company registers its IPO. That said, you can be sure the stock will be pricey on a P/E basis–IPOs usually are, especially hotly anticipated IPOs.
Business Plan. Additionally, both Apple and Google have business plans that have high “barriers to entry.” This means that other companies can’t easily set up shop and compete with either company. The same does not hold with Facebook. Sure, it is THE dominant social media site by far, but look how quickly it grew from zilch to its current status. Also, keep in mind how quickly MySpace went from #1 to much lower in the heap.
Social media companies, as they derive most to all of their revenue from advertising, have low barriers to entry. The next Mark Zuckerberg could be coming up with the next Facebook in a college dorm somewhere as I type. Additionally, social media is akin to fashion and retail clothing–very subject to consumers’ fickle whims.

Facebook IPO: The Bottom-Line

Buying stock on the day of an IPO is usually NOT a good idea unless you are well connected and among the lucky few who get offered a chance (by the investment banks underwriting the IPO) to buy at the IPO price. I believe a common misconception is that anyone can buy at the set IPO price. This is far from true. This is why articles touting how much a stock is up or down since an IPO are largely meaningless. For example, LinkedIn shares were priced at $45, but they opened at $83. An investor interested in buying shares at the market opening on IPO day bought them at about $83. In fact, he/she would have been lucky to pick them up at $83, as they soared to a high of $122.7 before closing at $94.25. At the current price of $67.89 per share, investors in LinkedIn have lost money unless they were among the select few who got shares at the IPO price.
I rather expect that it will be a good money maker for the first while. After about 6 to eight months expect it to level off. It will fluctuate but drift higher. I don't see the value increasing like Google has since the product is limited and there doesn't appear to be any way to expand or enhance the offering beyond "features" while Google is constantly adding value to the experience. So It’s likely best to wait until AFTER IPO day to decide whether you want to buy Facebook stock. You’ll be able to determine the valuation of the stock at the end of the first trading day. You’ll also be able to see if FB uses some of the boatload of cash its IPO will generate to make acquisitions to grow its non-advertising revenue. In my opinion, it needs to do just that. What do you think ?


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