Three Reasons to Avoid the Facebook IPO
Friending fever is about to hit Wall Street!
On Monday, multiple sources reported that Facebook is planning its initial public offering (IPO) for the third week in May.
It’s rumored that the social networking giant plans to raise $10 billion. That would make it one of the largest IPOs ever. It would also make Facebook one of the most valuable companies in the world, with a market cap of about $100 billion.
Talk about some serious hype!
Whatever you do, though, don’t buy into it. Instead, I recommend you avoid the Facebook IPO like the plague.
Here are the three most compelling reasons why…
Social Media Flops on Wall Street
The trend is supposed to be our friend on Wall Street. And considering that 19 social media IPOs debuted last year, before we even bother dissecting Facebook’s fundamentals, we should at least see how they performed.
In two words: Not good!
Kevin Pleines of Birinyi Associates found that 82.4% of last year’s social media IPOs are now trading below their opening day prices. And 57.9% (or 11 out of the 19) are trading below their offering prices.
Two of the most notable flops were Zynga (Nasdaq: ZNGA) and Groupon (Nasdaq: GRPN).
The former traded below the offering price on its first day of trading. As for the latter, it zoomed 55.7% higher on the first day of trading. Within weeks, though, the stock collapsed to trade below its IPO price of $20 per share.
In all seriousness, though, the reasons to avoid Facebook’s IPO extend beyond Wall Street’s poor reception for social media stocks as a group…
Slowing Growth Kills Stock Prices
When it comes to investing in IPOs, we’re investing in the future of the company. And if the company can’t keep growing, our investment is doomed.
One thing I can guarantee is that Facebook can’t keep up its torrid growth.
Case in point: In about four years’ time, Facebook’s user base went from 66 million to 800 million. If Facebook grows at the same rate over the next four years, its user base would hit 9.7 billion.
Like I said, I can guarantee Facebook isn’t going to keep growing that fast. There literally aren’t enough potential customers on Earth, as the world’s seven-billionth person was just born last October.
Realistically, Facebook should top one billion users this year, which is a growth rate of about 25%, year-over-year.
In other words, the growth is already waning. And slower growth doesn’t translate into higher stock valuations.
Especially since Facebook is already overpriced.
Sorry Mark, Profits Matter on Wall Street
Facebook Founder and CEO, Mark Zuckerberg, contends he focuses on products over dollars.
As he said in a recent interview with The Wall Street Journal, “The thing to take away isn’t that we don’t care [about business]. People for years were asking me why aren’t we trying to make more money. I would say I’m trying to build a business for the long term…”
Not focusing on profits is fine and dandy when you’re a private company. Not so much when you’re a public company. As we all know, Wall Street obsesses over profits. Every quarter. As a result, share prices ultimately follow earnings.
Even if Zuckerberg immediately wakes up to this reality, Facebook’s IPO is still grossly overvalued.
Consider: Internet giant, Google (Nasdaq: GOOG), trades at a market cap of about $200 billion and generates about $9.6 billion in profits. That means for Facebook to support its $100 billion valuation it would need to generate about $5.3 billon in profits.
That’s not going to happen before May. The company won’t even be generating $5 billion in annual sales by then.
Bottom line: If you believe that success in investing boils down to buying low and selling high, then don’t buy into the Facebook IPO. To profit from it will require buying high and selling higher… to a fool greater than yourself.
Ahead of the tape,