5 Reasons Why Investors Should Forget About The Facebook IPO

10th Feb '12 by Ben Hobson

3 comments 4183 reads

With Facebook having finally announced plans for its long anticipated IPO this spring, speculation is already rife about the social network’s likely gigantic valuation and how the shares will go on to perform. For investors with anything short of many millions of dollars to invest, the circus surrounding what is expected to be the largest ever tech IPO will be one to watch rather than partake in. But even assuming we all had the money and the invite, should the prospect of diving in to the hottest ever IPO be an attractive option?

Despite the fact that CEO Mark Zuckerberg has yet to name his price – will he aim for a $100bn valuation? – the Facebook IPO has already been analysed from every angle. On one hand, commentators have muttered concerns about Zuckerberg’s letter to prospective investors (too wishy-washy), they’ve raised fears about a flood of advertising damaging user loyalty, and even questioned why the company is floating and raising money at all (when it could conceivably get away without doing either).

Supporters may claim that Facebook's best years are almost certainly ahead of it and, with 500 investors on the books, Facebook was already facing statutory reporting requirements, so why not squeeze some cash out of the situation? Likewise, Zuckerberg clearly has lofty ambitions, and a mega-fundraising is going to give him all the comfort he needs to achieve them.

But as regular readers will know, rather than chasing speculative story stocks, we believe in an evidence-based approach to investing that avoids falling foul of our innate behavioural biases. So what does the empirical research say about IPO investing? Well, to get the pulse racing, it's true that there is a mountain of research suggesting that a heady mix of behavioural finance and asymmetric information causes many flotations to get away at artificially low prices. The immediate consequence is often a first-day trading spike that makes a mint for anyone lucky enough to be holding the shares – particularly if they choose to ‘flip’, or sell them, for a profit. For investors thinking of buying shares in the aftermarket, of course, that means the Facebook IPO should be treated with extreme caution.

More generally, though, the research suggests that flotations of all sizes should carry a health warning and Facebook is no different, notwithstanding the frenzy of media attention and noise…

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AnonymousUser3343

11th Feb '12

Thanks Ben, nice article. Facebook has been a phenomenal success, the story is one I often cover when teaching business enterprise. I usually lead into the Facebook story by starting off with a case study of Friends Reunited, who most of the learners have never heard of! but in its own way was a good UK early entrant in this market place around the time of the dot com boom and bust period. It made the entrepreneurs very wealthy when they sold to ITV, it turned out to be a disaster acquisition for the media company. Will Facebook still be as popular in 5+ years I’m not convinced, neither am I convinced that Mark Zuckerberg will welcome the intense scrutiny and demands following the IPO which is why I would personally leave it alone when available on the open market.

schober

12th Feb '12

hmm .................. in my very limited survey, 9 accounts, chosen at random, were dormant and only one active ( active = something had happened in last 4 weeks) - cant help but be sceptical about those user numbers

Roger Lawson

17th Feb '12

This is what I said on the ShareSoc blog about the Facebook IPO a couple of days ago:

Irrespective of whether the Facebook IPO is at a fair price, is it one you should consider? The valuation could be as much as US$100 billion (£63bn), which makes founder Mark Zuckerberg’s stake worth as much as $24bn. But it seems that does not satisfy him enough – he also wishes to maintain control of the company by the use of dual share class structure where he has 57% of the voting rights. This would be similar to that used by Rupert Murdoch to control his business empire.

Facebook made a profit of $1bn in 2011 so the valuation is a pretty enormous multiple of earnings. Although the company has 800 million “users” worldwide, that values each of those users at $125 – this is the kind of multiple that was being paid for businesses in the dot.com bubble era based on their customer numbers, which of course turned out to be impossible to convert into profitable revenue in most cases. A lot of those 800 million are probably “inactive” users as well, and the effectiveness of advertising on Facebook, which is where most of their revenue comes from, has yet to be proven. Advertising revenue is forecast to be $4bn in 2012 and $5.5bn in 2013, but there are doubts as to whether advertisers will continue to pay to attract Facebook users when they may be able to do it via viral marketing themselves so those forecasts may be way off.

If you still think it’s cheap enough and you want to take a slice of this “gorilla” in the internet social media space, you should particularly bear in mind the dual share structure because such arrangements tend to have a negative impact on the share price of a company in due course. Also if the company does get into difficulties, it can be difficult to get changes made.

5 Reasons Why Investors Should Forget About the Facebook IPO

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Ben Hobson

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