Why You Shouldn’t Buy Facebook: Part-1

Zuckerberg Facebook IPOThe Facebook Fizzle

On Friday morning I brewed myself a nice strong cup of coffee and happened to catch the debut of Facebook (FB). This was the much anticipated IPO (Initial Public Offering) of a prize race horse about to belt off the starting line. I felt that I was watching a part of history for the largest IPO in history, and BNN proudly had a real-time quote taking up the whole screen ready to go! The opening however was marred by a lengthy half-hour delay. Once Facebook shares started to trade from the IPO price of $38, FB shares went as high as $42 within minutes of opening, and settled back to a closing price of $38.23 by the end of trading day (See chart below).

This was obviously a win for day-traders who already were able to purchase their shares at the IPO price of $38 and offload them at $42, a tidy 10% return for a few minutes of work. But for those investors who bought in after the IPO, they have already lost money, and I believe they may even lose more in the weeks to follow.

Facebook on first day of trading

Facebook stock price on IPO Day (Globe and Mail)

Before the opening bell, the underwriters of Facebook valued the stock at $38 a share, pricing the company at $104 billion. This is the largest valuation to date for a newly public company. Throughout the day, over 580.4 million shares traded for Facebook, also making it the largest IPO by volume. According to a CNBC post, Some 82 million shares changed hands in the first 30 seconds and volume passed 100 million after four minutes. The Facebook IPO on Friday was certainly history being made on those two counts, valuation and volume of shares.

What wasn’t historical was the less than stellar close of the stock price only 23 cents above its initial offering price, which disappointed many in the financial community. According to an article in the Wall Street Journal, Facebook struggled to stay above the IPO price for most of the day, forcing underwriters to buy back shares to support the price. Compare this to the IPO of LinkedIn last May, where shares of LinkedIn rose as much as 171 percent in the first day of trading on the NYSE, closing at $94.25 per share from the opening IPO of $45 per share.

Some would say that the IPO price for Facebook was fairly valued by the underwriters, since it stayed near the IPO price, and perhaps it’s a relief investors didn’t get carried away and shoot for the moon. Others view the less than spectacular rise in Friday’s Facebook share price, and lengthy opening delay, as a bad omen – an early sign of things to come. Regardless, it’s too early to tell, and generally never a good idea to buy stocks on IPO day.

The Top 10 Reasons

Now that Facebook is a publically traded company, and the IPO has already debuted, here are the Top 10 Reasons why you shouldn’t even consider buying Facebook:

1. IPOs Are Risky Investments

IPO’s (initial public offerings) are inherently risky investments because they simply have no history. When you buy an IPO you are placing your trust on future earnings, potential growth, and your future belief in a company. Generally recent IPOs haven’t fared very well.

Take the recent IPO of Groupon Inc. (GRPN) last November as an example, another online IPO megalith like Facebook. Groupon’s IPO was valued at over $12.7 billion dollars, far short of Facebook’s $100 billion. Groupon’s IPO was also received with much optimism and hype, and shares soared eventually closing at $26.11, a 30.55% increase above the $20 IPO price. After numerous legal proceedings and questions of conduct and accounting practices, Groupon trades at $11.58 per share. This is an overall loss of over 50% for investors who bought in on IPO Day.

LinkedIn (LNKD) was another social media giant IPO launched last year in May 2011.  Investors have been taken for a gut-wrenching ride on this IPO, with share prices oscillating wildly between $100 per share, down to $60 and back up to the closing price on Friday of $99.02 per share. But LinkedIn has fared much better than Groupon. For those investors who had the stomach of steel to hold their LinkedIn shares or bought at the bottom, they would have had a positive return. But for investors who sold after the initial decline in share price, this would have been a sharp loss to swallow.

IPO’s are always going to be a wild ride, especially with high-profile companies. So what makes Facebook different?  That’s the $100 billion dollar question. 😉

2. Facebook may be overvalued

Facebook filed for an initial public offering on February 1, 2012, and the preliminary prospectus stated that the company was seeking to raise $5 billion. Before the IPO the underwriters valued Facebook at $38 a share, pricing the company at over $104 billion, the largest valuation to date for a newly public company. During the trading day, those underwriters had to buy-back shares to keep the price above the $38 IPO price.

[easyazon-image-link asin=”B007TC3ZB8″ alt=”The Facebook IPO Primer” src=”http://ecx.images-amazon.com/images/I/51hS%2BzI5kPL._SL500_.jpg” align=”left” width=”187″ height=”250″]

$100 billion dollars is not pocket change. To put this amount into context, Apple (AAPL) is valued at over $494.5 billion, Microsoft at $245 billion; Google is valued at $195 billion and Amazon at $97 billion. A stalwart blue-chip stock like Johnson and Johnson is valued at over $173 billion, and Canada’s largest bank, the Royal Bank, is valued at $74.5 billion.

With the lofty valuation for Facebook at top end, it’s no surprise Facebook Shares barely budged in trading, and were slow off the finish line. Is Facebook the next Google or the next Apple? Should investors rush in to grab a piece of history or stand on the sidelines and wait? I believe investors should hold off on Facebook and give some time before making a decision, at least until first quarter results. The real question investors should ask themselves is whether facebook is really a $100 billion dollar company, and whether that valuation is sustainable?

In Part-2 to help understand the question of Facebook’s valuation, I’ll look at some of these metrics in more detail. These metrics include:  the business model, the revenue model, accountability as a public corporation, potential privacy and legal issues, as well as the lack of shareholder control. It will be interesting to see how Facebook shares do on Monday morning and throughout next week. 😉

Continue to Part-2

21 Responses to “Why You Shouldn’t Buy Facebook: Part-1”

  1. Kurt @ Money Counselor

    May 20. 2012

    Ninja: What do you think the chances are that FB has already hit its all-time high price?

    Reply to this comment
  2. Eddie

    May 20. 2012

    Avrom,
    Great article. You raise some very valid points. I always said even before FB launched that it will be hard for FB to live up to all the hype, simply because it’s slowly running out of ideas on generating new income streams. I wasn’t surprised at all to see the stock close 23 cents higher, after a lot of people expected the stock to double or triple on Friday.

    Reply to this comment
    • The Dividend Ninja

      May 20. 2012

      Eddie, thanx! Wait till you read Part-2. 😉 The problems for Facebook are many, even if it is an established social media giant. The top end valuation of $100 billion leaves more rooom for decline than an increase. We shall see…

      Cheers!

      Reply to this comment
      • Eddie

        May 21. 2012

        Yes, we shall see.
        The more I think about FB, the more I can’t come up with any possible new revenue generation. Unlike Google, who runs 95% of the online searching, their options are unlimited for bringing in additional revenue.

        Reply to this comment
  3. Poor Student

    May 20. 2012

    While I will not be buying Facebook, I must disagree with the “never IPO’s on IPO day”. I just read The Intelligent Investor, the latest edition with commentary by Jason Zweig.

    I forget the number but traders can clean up on IPOs. If you buy at the opening and sell the next day you net a very tidy profit. This doesn’t fit into my investing strategy or yours but it can work for lots of people.

    That was just being the devil’s advocate. I don’t consider IPOs and think that Facebook will not prove to be a great investment at these prices, and look forward to reading your other eight reasons.

    I have missed your writing Ninja!

    Reply to this comment
    • The Dividend Ninja

      May 20. 2012

      Hey Poor Student, thanx its good to be back – though full time work doesn’t feel like much of a break!

      If you can get in at the IPO price, then sure you could make some nice change on the swing in price over a day or two. Only problem is very few people are able to get the IPO price. In the case of Facebook many people have already bought in at the $40 plus price point.

      Cheers!

      Reply to this comment
  4. My Own Advisor

    May 21. 2012

    Well written article.

    I’ve read so often, don’t buy into IPOs, so I don’t.

    IPOs are mostly about hype, a trader’s dream.

    I prefer to own companies that people don’t talk about very much, don’t trade very much, rather, they take the company and its products for granted. Those are the companies you want to own for the long-haul…at least I do 🙂

    Maybe I’m missing out on the next Google, but that won’t bother me. I like to know where my cash flow (dividends) and gains will be coming from. Facebook, who knows where this will be in 10 years.

    I guess that makes me a conservative investor, or like Dividend Ninja.

    Reply to this comment
    • The Dividend Ninja

      May 21. 2012

      MOA nice to have you drop by. 😉 I would take your investing approach any day over a potential high flyer like Facebook. Even though Facebook has been around for 8 years, and obviously has some type of moat around it in the social media scene – investing in it is another matter. So far Facebook (FB) opened the bell 12% lower…

      Poor Student had an interesting comment on IPOs, I’m going to have to check out that article he referred to.

      Cheers!

      Reply to this comment
  5. Nice topic. I agree that IPOs are generally very risky considering the hype around many companies going through an IPO.

    On the other hand, not all IPOs are risky since preferred shares from well established companies also go through IPOs. The reason I mention that is that you might not want to ignore the IPO notification feature from your broker – I regularly see income oriented investment. I know that’s not the kind of IPO you were referring to here.

    FB is definitely not for me. Did you notice how Zynga got dinged during the IPO … Both of them are in bed with each other and depends on each other for revenues at the moment.

    Reply to this comment
  6. Peter

    May 21. 2012

    Shares are already down on Monday.

    Reply to this comment
  7. Nikita Sharma

    Jun 09. 2012

    From the point of view of the company , Facebook itself, of course it was a roaring success. They were able to raise a good chunk of capital to develop and expand the business. That’s what an IPO is, at heart, about. Early investors in the company did well too: they were able to cash out some portion of their earlier investment at good prices.

    Reply to this comment

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