The Facebook IPO: What's Not to "Like"?

Actually there is plenty not to like.  If there was a ‘dislike’ button I would certainly click it.

If I had a dollar for every time someone has asked me about the Facebook FB IPO in recent weeks, I’d have almost as much money as Mark Zuckerberg.  Facebook mania seems to be sweeping the nation and investors are apparently tripping over themselves to get a piece of the hottest initial public offering in recent memory. 

Here are the problems with this whole situation, as I see them. 

First, I don’t have any insights into what true demand will be but if word on the street is any indication it will likely be closer to the high end of the expected price range of between $34 and $38 per share if not above it.  Investment bankers are smart so they will price this appropriately to maximize the gain for both Facebook and themselves.  If history is any indication, getting into a bidding war to own something ‘hot’ - whether it’s the latest tech stock or a McMansion - rarely ends well for the buyer (see recent history for examples).  

Second, while it may be unfair to unilaterally lump Facebook in with many of the dot.com names of the late 90’s there are some striking similarities.  Unlike some of the hot tech names of years past, Facebook actually generates revenue and is a real business. But, like many of those same names (Webvan, pets.com and countless other internet flops) investors seem all too willing to overpay to play.  Facebook could be a great investment – at the right price. 

Speaking of price, Facebook is expected to have a valuation of about $100 billion following the IPO (assuming most options are exercised).  To put it in perspective that’s about the size of companies like McDonald’s, Verizon Communications and Pepsi Co.  Facebook also had about $1 billion in earnings during 2011, significantly less than all three of the above firms.  In short you are paying a lot more for every dollar of revenue.  Scrutiny to hit revenue and growth targets will be high and the smallest hiccup could cause big moves down.  The downside risk is much larger than the upside potential. 

Factor in that General Motors GM just diverted $10 million per year of their ad budget from Facebook to other media and you have to ask yourself whether others will follow.  Better yet, ask yourself if you’ve ever clicked on a Facebook ad, or even noticed them for that matter?

If you simply must invest in Facebook, shorting the stock seems like a better bet to me.  All told, the question shouldn’t be where and how you can invest in Facebook.  The question is why would you want to?  If we revisit this article a year from now and I turn out to be wrong, I will be the first to post mea culpa on my Facebook page.

About the author: Michael Prus is the President and Founder of Scale Investment Group, LLC, a registered investment advisory firm based in White Lake, Michigan. The company manages money for clients and is a consumer advocate, most notably championing greater transparency of the investment advisory industry and lower fees for investment products as well as portfolio management services. Contact Michael directly at mprus@scaleinv.com.