“How can I buy Facebook stock?” my former colleague’s sister-in-law asked him.
“Do you have a brokerage account?” he replied.
Ah, the unmistakable sound of hype, and you know similar conversations are happening all over. I’ve been asked about Facebook’s IPO countless times, and you probably have been, too.
There’s no shortage of opinions about it, which isn’t necessarily a good thing. Some are sound; many are not. I’ll cut right to the chase: Should you buy Facebook? I’m not. Instead, I have my eye on a much better IPO opportunity right now.
After the Hype
It makes sense, actually, that Facebook would be one of the most hyped IPOs in the 25+ years I’ve been in the investing business. Social media is all about spreading the word, and Facebook is king (for the moment anyway), so why wouldn’t there be a viral-like hype?
That hype isn’t going to go away at 9:31 a.m. on Friday, May 18, a minute after FB becomes a tradable ticker symbol. Most individual investors aren’t going to get in on the actual IPO, but an awful lot of people will buy the stock (provided they have brokerage accounts) because it’s the thing to do. The word is that individual investors are very interested in FB but the institutions less so.
Within a matter of days or weeks, the mania will begin to fade, and the stock will start to be valued on the company’s merits. That’s when the reality starts to disconnect from the hype. So, if you feel compelled to buy Facebook, my advice would be to get in early but don’t stick around very long.
Valuation is already a concern. At around $35 a share, Facebook would have a market capitalization of about $100 billion. That’s pretty rare air, and downright crazy if you ask me. Fewer than 40 companies that trade on U.S. exchanges, including foreign companies, have a higher value. If Facebook were to hit that valuation, it would be valued higher than established behemoths such as Abbott Labs (NYSE:ABT), Visa (NYSE:V), McDonald’s (NYSE:MCD), Cisco (NASDAQ:CSCO) and Disney (NYSE:DIS).
Plus, at the market cap, Facebook would basically have a P/E around 100x and be valued at 25x revenues of $4 billion. That price-to-sales ratio is more than 2.5x what Google sold for when it went public.
And while we’re on the subject of revenues, Facebook’s fell 6% from the fourth quarter of last year to the first quarter of this year. Some of that can be chalked up to seasonality — you expect a weaker first-quarter for an ad-driven business — and sales were still up 45% over the same period the previous year. But investors aren’t in a forgiving mood when they’re paying 100x earnings to buy a stock.
In the bigger picture, social media is a finicky industry, and a lot of companies want a piece of it (Google+ for instance), so you have to wonder about Facebook’s staying power. Remember when MySpace was king? There are also questions about Facebook’s ad rates, reports that the company doesn’t let advertisers track how their ads are doing like Google (NASDAQ:GOOG) and Yahoo (NASDAQ:YHOO), and concerns over the company’s not fully developed mobile strategy — a big concern considering most people access Facebook on their smartphones.
So, while there’s no doubt that Facebook has been a game-changing company, there’s plenty of doubt about whether it will be a game-changing investment. For that, I think the odds are much better for another company that just had its own IPO.
Funny Name, Serious Business
Splunk (NASDAQ:SPLK) just began trading April 20, four weeks before Facebook’s debut. It actually did quite well, doubling from its IPO price in its first day of trading. Still, that only helped the insiders and institutions who were able to get shares before they started trading. For everyone else, the stock traded between $33.50 and $36.64 that day.
This is a well-defined business operating in an important area of technology right now — what’s called “big data.” Corporations and their IT departments are overwhelmed by data in this digital age. This data can be extremely valuable in strategic planning and decision making, but getting a handle on it is the problem.
That’s what Splunk does. The silly-sounding name comes from the word spelunking, which is exploration of caves. As the company says on its site, “Our customers told us that finding their IT problems was like ‘digging through caves with headlamps and helmets, crawling through the muck.’
Splunk makes software to collect and organize the head-spinning amounts of data so corporations can examine it and make better business decisions to increase speed, lower costs, reduce security risks and more.
If you look at the huge acceptance Spunk’s software is receiving in the marketplace, you’ll see why the stock was received so well by investors. In the company’s last fiscal year, revenue increased 245% from $35 million to $121 million. Revenue for new software licenses, which pave the way for future growth, jumped 225% from $27 million to $88 million.
You can see the bulk of revenue comes from new sources. Eventually, revenue from ongoing software maintenance and support grows as the customer base builds. In other rapidly growing software companies, such as Solar Winds (NYSE:SWI), maintenance and support sales eventually reached over 50% of new license revenues, so you can see the snowball-like opportunity that can result.
SPLK’s valuation is a bit challenging at 25x enterprise value/revenues. Still, the company is growing rapidly and operating in a market with huge potential, and sometimes you have to pay up for those stocks.
It’s not likely to be a screaming bargain anytime soon, and a good time to buy might be when the lockup expires in the fall. That’s when large shareholders and the banks that brought the company public are free to sell their shares. Stocks often dip at that time as those investors cash in what are likely to be big profits from the initial $17 price.