Market Overview

Think Like Groucho Marx, and Four Other Tips for Avoiding the Next Facebook


By Michael Comeau, Minyanville

Did you get burned by Facebook (NASDAQ: FB), thinking that getting a few shares of Wall Street's next sure thing would make you big bucks, as some TV prognosticators insisted?

If the answer is yes, or if you'd like to avoid stepping in similar steaming messes of you-know-what in the future, I encourage you to remember that through every disaster in life, financial or otherwise, there are lessons to be learned.

Facebook, now down 31% from its $38 offering price, qualifies as such a disaster.

So here are five tips for avoiding the next flaming IPO mess:

1. Accept That You Are a Nobody

In late November, I made the following point about the individual investor's place in the financial landscape (see: Why Wall Street Needs the Serenity Prayer):

I'm just pointing out that if, as an individual investor, you haven't known that the deck's been stacked against you all along, then you just haven't been paying attention.

As we now know, the bigwigs at Facebook tipped off the IPO underwriters that the second quarter wasn't shaping up as well as expected, a revelation that was passed on to only a select few big institutional clients.

Now why didn't everyone get the bad news? Simple -- because in most businesses, big customers get treated better than small customers.

Unless you are doing huge, huge business with your broker, the firm just doesn't care about you all that much.

So who gets the full-spa treatment at a big investment bank like Morgan Stanley (NYSE: MS)? Fidelity. SAC Capital. PIMCO. Not you.

Get over it -- this is just the way the world works. In terms of money, I'm a nobody, and I hope that accepting my place in the world puts me on the track toward being a somebody.

2. Think Like Groucho Marx

Groucho Marx said: "I don't care to belong to any club that will have me as a member."

As an individual investor, that's the attitude you should take when Wall Street cuddles up and offers to do you a favor -- like cut you in on what was supposed to be a red-hot, highly-coveted IPO.

The fact that extra Facebook inventory suddenly became available was a red flag that demand from big clients -- a.k.a. the full-spa types -- were balking at the deal. When the big, well-connected run, follow them. Or at least pay attention to what's going on!

3. Read the Stupid S-1

An S-1 is the SEC's code name for IPO offering document, which basically provides you with an extensive rundown of the company's operations and financials.

Now why is Facebook's revenue growth slowing? Simple -- increased use of mobile apps that don't generate meaningful revenues for the company. Anyone who read Facebook's S-1 would have picked up on this.

Here's an excerpt from Facebook's first S-1, filed on February 1, 2012:

Although the substantial majority of our mobile users also access and engage with Facebook on personal computers where we display advertising, our users could decide to increasingly access our products primarily through mobile devices. We do not currently directly generate any meaningful revenue from the use of Facebook mobile products, and our ability to do so successfully is unproven.

Now let's look at the amended S-1 Facebook filed on May 9, 2012:

In March 2012, we began to include sponsored stories in users’ mobile News Feeds. However, we do not currently directly generate any meaningful revenue from the use of Facebook mobile products, and our ability to do so successfully is unproven. We believe this increased usage of Facebook on mobile devices has contributed to the recent trend of our daily active users (DAUs) increasing more rapidly than the increase in the number of ads delivered.

So in February, Facebook admitted upfront that it had no meaningful mobile revenues, and in May, it signaled that mobile was a drag on ad-serving activity. Now keep in mind, the S-1 was chock full of references to the company's mobile efforts, including this one:

We are devoting substantial resources to developing engaging mobile products and experiences for a wide range of platforms, including smartphones and feature phones. In addition, we are working across the mobile industry with operators, hardware manufacturers, operating system providers, and developers to improve the Facebook experience on mobile devices and make Facebook available to more people around the world. We believe that mobile usage of Facebook is critical to maintaining user growth and engagement over the long term.

So did you really need someone to leak to you the problems regarding mobile, and the importance of mobile to the company's future?

If you read the S-1, or at the very least, read the work of those of us who did, you would have been well aware of Facebook's issues. In February, I was interviewed at the NYC Moneyshow, and even then, well before the May 9 amendment of doom, the S-1 had revealed all of Facebook's issues.  Here's an excerpt:

So Michael, there’s a lot of hype about Facebook, and that’s not always a good sign for an IPO, but this one may be different. What are your thoughts?
The interesting thing about Facebook is that I think it’s actually coming public fairly late in its lifespan. I mean, they already have 845 million users, and their addressable market—you’re only going to have two or three billion people—so they’re already pretty far along in their growth.

When you think about it, a lot of these newer customers, they’re on mobile phones. They’re in emerging markets—very poor countries—so these are not the best advertising targets in the world.

Now, if you look in the S-1 and you look at how revenue per user is growing, it’s starting to flatten out. And since user growth is slowing and that number isn’t going up, you’ve got a really bad recipe for a revenue slowdown.
You mentioned mobile, and I know one of the things they talk about in their S-1 is that in mobile, they’re not making money right now. Is that a concern?
Well, they have to be in mobile, just because that’s what people want. But it’s absolutely a concern.

If I’m Facebook, I want people using it on their computers. I want them looking at ads, and when I pull out my iPhone, and I pull up Facebook, I see no ads. They’ve got to figure out a way to do that which doesn’t kill the experience, and that’s going to be their challenge.

Trust me -- I'm no genius. But I read the S-1 and found out everything I needed to know about Facebook's mobile issues. Yes S-1s are long, and yes they are boring, but they also contain mountains of fundamental information and they identify risk factors of which you may not be aware.

4. Consider Alternative Names That Are Already Publicly-Traded

The older I get, the more I realize that the vast majority of publicly-traded companies are pretty much interchangeable pieces of paper, particularly in today's highly-correlated risk-on/risk-off market. When we're in risk-on mode, it doesn't really seem to matter if you're buying tech or financials or oil. All the risk-on stuff goes up.

Facebook is a momentum stock. That means it goes up a lot when the market's strong and/or good news is reported, and it gets smashed when things go bad. The IPO was a mess from top to bottom and the fundamentals are deteriorating, so it's getting the ugly-stick treatment a là Netflix (NASDAQ: NFLX) in 2011.

So when a hot IPO is coming, remember that there almost always are existing publicly-traded names that can give you the type of action you're seeking in terms of the risk-on/risk-off paradigm. For example, if a hot tech stock is coming public, you can probably emulate its performance by grabbing something like Apple (NASDAQ: AAPL) or (NYSE: CRM).

5. Beware of Media Hype Jobs

There were quite a few market commentators and analysts pumping the heck out of Facebook in the months leading up to the deal.

Perhaps they didn't seem to notice that Facebook sported a deadly combination of

  1. obviously deteriorating fundamentals, and
  2. a sky-high valuation, or maybe they expect a sharp increase in mobile-ad revenues.

Who knows?

Either way, Facebook's flop is a great illustration of why it's important to do your own homework and examine multiple points of view (See: 10 Takes on the Facebook IPO) so you can cut through media hype and make an informed decision.

For every cheerleader, there's a naysayer. Listen to both, and then go your own way.

More from Minyanville:

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

Posted-In: IPO markets personal financeTopics Markets Tech Trading Ideas General


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