A decision to invest in Facebook (FB) is complicated and should be based upon hard facts, an accurate assessment of risk, reasonable speculation about future events and good judgment. It is not one that should be made based upon emotion. FB is a cool company, but we are talking about giving them our money as investors.
I am not a financial advisor; as such, I am not registered to make stock recommendations. I will present selling points and risk factors relating to Facebook that I have read, heard or extracted from the company’s SEC documents. Before making an investment, you should read FB’s S-1 and consult with a financial advisor.
The selling points relating to FB are known far and wide. The company’s mission is to “make the world more open and connected.” It has done this with great success in the few years since its inception. FB has 800 million monthly active users, 483 million average daily users, 100 billion friends connections, 2.7 billion likes and comments in a recent three month period and it posted $3.7 billion of revenues and $1 billion of net profits in 2011. These performance standards resulted in the company receiving a valuation of over $100 billion (and a mega price/earnings ratio of over 100) in its recent initial public offering making it one of the largest companies in the world from a market capitalization perspective. Most respected Dow Jones companies have price/earnings ratios between 10-20 at this time.
But there are many risk factors associated with owning FB stock beginning with the performance of the stock yesterday after it started to trade at about 11:30 a.m. Some of the commentators on CNBC gave a minute by minute account of why the stock opened at the level it did and whether it was an attractive investment for buyers after the stock began to trade. For one thing, the smartest money (institutional investors, hedge funds, other sophisticated investors) is generally selling immediately after an IPO while the most unsophisticated money (retail clients) is buying. As with most high tech companies, venture capital firms provided seed capital to FB at very low prices. They own low cost stock because they took significant investment risk at a time when the company had not yet proven itself. So, it is conceivable that the supporters of FB over the years own stock at prices under ten dollars per share and made three or four of five times their money at the IPO price of $38.00.
Another important fact is that tech IPOs have historically sold up an average of over 80% after the IPO. FB sold up a modest 5-10%. This means that the underwriters accurately priced the IPO and left little on the table for those who were not allocated share during the IPO process.
The SEC documents delineate the risks associated with an FB investment. The following is an abbreviated list of them:
• The ability of the company to retain and add new users. If the company cannot grow at a rapid rate, its stock price will decline.
• Advertising is a substantial part of revenues. The loss of General Motors business is indicative of what might happen if other advertisers do not feel they are getting the pop from their FB advertisements.
• Mobile product growth may decrease ad revenue because it does not display advertisement.
• Growth and engagement with new customers is dependent on mobile operations systems, networks and systems not controlled by FB.
• It is a highly competitive business. The company will be going head to head with Google in certain areas.
• Improper access to or disclosure of user information may harm FB’s reputation.
• The CEO has control over key decision making because of his huge stock interest. And, the loss of Zuckerberg or Sandberg or other key employees could hurt FB’s operations.
• After a short lock-up period, the stock market could be inundated with millions of new shares from employees and other holders that will depress the market value of the stock.
• Acquisitions will be costly and consume a great deal of management time.
• Management is unproven. This is a young company that investors are expecting great performance from. Many FB employees are not seasoned and this could hurt FB during difficult times.
Investment in FB stock at this time is problematic. It is hard to believe that FB will not be a grand slam homerun long-term. But, I think potential investors should be extra careful until the dust settles, the lock-up period passes and the overall market improves.