Should You Buy the Facebook IPO?

What you should know about the biggest social media deal ever

   

It’s been a long time coming, and now it’s finally near — the Facebook IPO is only a day away. One of the most hyped initial public offerings in recent history has only gotten hotter, with both the price range and the number of shares made available getting juiced this week.

The demand is screaming and worldwide. In fact, even tech luminaries are preparing to buy shares, including Apple (NASDAQ:AAPL) co-founder Steve Wozniak, who said he’ll buy the shares at any price.

But should you?

It might be tempting to jump in, but you should always do your homework first. Before you decide to jump headfirst into the social media IPO to beat all social media IPOs, let’s take a look at the primary pros and cons of Facebook:

Pros

Leadership: Mark Zuckerberg has an innate sense of what makes for highly engaging technology. Facebook was no accident — before he created the social network, he already had developed several other highly popular apps.

Zuckerberg has been smart enough to surround himself with other smart people, such as the co-founders of companies like PayPal, LinkedIn (NYSE:LNKD) and Zynga (NASDAQ:ZNGA). He also has shown that he can make tough decisions. For example, Zuckerberg launched the News Feed in 2006 and refused to pull it against a wave of protests, instead choosing to tweak it down the line to gradually improve the experience.

And Zuckerberg also has the all-important resolve to fire people, exemplified by the pushing-out of co-founder Eduardo Saverin, who he considered to be a drag on the company.

Investor Interest: Facebook is likely to be a cult stock — that is, many investors and fund managers will take a position in FB simply because of its marquee status. Also, the enormous market value of Facebook automatically will make FB part of many indices for exchange-traded funds after a few weeks, which will drive even more demand for the shares.

Strong Financials: If the Facebook IPO prices at $38, the company will be able to put more than $10 billion in the bank. No doubt, that kind of cash horde will be pivotal as it competes against companies like Google (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) for acquisitions.

Amazing Platform: Facebook has extensive demographic information on almost 1 billion people, making it possible to target ads based on factors like age, gender and interests. It’s essentially the holy grail for marketers.

Brand: Facebook is one of the most valuable brands in the world, and the name is synonymous with social networking. With so much noise in the global marketplace, a top-of-mind brand is incredibly important, especially for sustaining a company’s growth.

Cons

Monetization: Zuckerberg has been clear that monetizing Facebook isn’t a big priority; instead, he worries mostly about the consumer experience.

Unfortunately for investors, this focus might be too lopsided for comfort. So far, despite its gains, Facebook’s business model has been fairly lackluster, with most of its revenues coming from display ads, and another chunk coming from Zynga’s games.

If Facebook wants to get its revenues going, Zuckerberg needs to put much more focus on catering to marketers. General Motors’ (NYSE:GM) bombshell of nixing its $10 million Facebook ad spend raises serious concerns about a pushback from other major brands. If this trend starts to spread, it could result in an enormous drag on revenues.

Mobile: You actually could lump this problem in with monetization. More than 500 million users access Facebook with mobile devices; unfortunately, that growing number is eating into the core revenues from the desktop business. Because of the small form factor, Facebook’s ability to display ads is severely limited compared to the desktop, where it can show as many as seven — which means more revenue. Also, because mobile advertising is in the experimental phase, brands are requesting lower ad rates for taking on the additional risk.

Competition: Facebook’s business is too big for rivals to ignore. For instance, Pinterest has been gaining speed in social networking, and of course a key reason Facebook spent $1 billion on Instagram was to eliminate it as a competitive threat. But with the recent surge of venture capital, it is likely that more and more new competitors could rise to the forefront. At the same time, the company will have to fend off pressure from the major players. Google still hasn’t given up on the G+ dream, and even Apple has plans to make iCloud more social. It’s naive to think Facebook is invincible.

Fad: It’s hard to think that something so ubiquitous could be a fad, but half the respondents of a recent AP/CNBC poll said Facebook was indeed that. And that’s a chilling thought, considering the consumer Internet space is littered with examples of flameouts. Think AOL (NYSE:AOL), MySpace, Lycos, Excite, Yahoo (NASDAQ:YHOO), AltaVista, eToys, Geocities, and on, and on, and on …

Verdict

In addition to the above concerns, investors will face a couple big risk factors the second Facebook starts trading Friday.

For one, Facebook’s valuation is going to be awfully lofty. It likely will open trading around 25 times revenues and almost 100 times earnings — if not more! That’s Amazon (NASDAQ:AMZN) country. Sure, a valuation like that is reasonable if Facebook can grow at a fast rate. For example, if Facebook averages an annual growth rate of 50%, it would reach the same level of revenues as Google — about $40 billion — in six years. However, even at a still-brisk 30%, it would take nine years to get that far.

Even if you think Facebook will be able to keep up the growth momentum, it’s still risky to buy the stock right after its IPO thanks to hype alone. Just look at some examples of how other hot IPOs have fared just six months after their offerings:

Company Ticker Return
Groupon GRPN -61%
LinkedIn LNKD -23%
Yelp YELP -15%
Zynga ZNGA -10%

So, should you buy the Facebook IPO? Yes — but not right away. Facebook has the potential to make investors a lot of money, but if you give the company a couple months to cool off, you should be able to get in on its long-term success at a far better price.

Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook”, “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/ipo-playbook/should-you-buy-the-facebook-ipo/.

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