Three Reasons Why I’m Not Buying The Facebook IPO

| May 7, 2012 | 0 Comments

The month of May 2012 is set to go down in history.  It will forever be remembered as the month Facebook finally went public.  That’s right.  After months of speculation, the most highly anticipated IPO of all time is nearly ready to go.

And if it all comes off as planned, it will be the fifth largest IPO in US history.

Facebook’s IPO is scheduled to take place on Friday, May 18th.  The company plans to sell about 377 million shares at a price between $28 and $35 per share.

If the stock is priced at the high end of the range, Facebook will be valued at nearly $100 billion.  And the company would rake in about $13.6 billion from the sale.

What’s even more amazing…

Such a valuation would make Facebook the most highly valued company at IPO in stock market history.

That title is currently held by United Parcel Service (UPS), which was valued at $60.2 billion on its IPO in 1999.  And it would give Facebook a much bigger valuation than Google‘s (GOOG) $24 billion at IPO in 2004.

Why are Facebook shares so high in demand?

Investors are convinced the company is going to make boatloads of money going forward.  Facebook is after all the most popular social networking company on the planet.  With over 900 million active monthly users worldwide, the company has a huge, captive market to which it can sell all sorts of goods and services.

And so far, the company is making money hand over fist.

Last year Facebook earned $1 billion on revenues of $3.7 billion.  That’s year over year growth of 52% and 88% respectively.

However, despite this phenomenal growth, I’m not buying Facebook shares on the IPO.

Here’s why…

First off, the proposed IPO valuation for Facebook is just too high.  If the shares price at the high end of the range, the company would be valued at 99x earnings.

In fact, Facebook would have a higher P/E than every member of the S&P 500 Index other than Amazon (AMZN).

While I like Facebook’s business model as much as anybody, I’m not prepared to pay any price for it.  And neither should you.  Remember, it’s very difficult to make money on a stock if you overpay for it.

Try this on for size…

The Wall Street Journal recently talked to Morningstar analyst Rick Summer about Facebook’s upcoming IPO.  According to the article, Mr. Summers said this…

“The only way to justify even the low end of Facebook’s valuation would require the company to make $40 billion in revenue within the next six to seven years, while maintaining the same profit margins.”

That’s a tall order… even for Facebook.  If Mr. Summers is right, the company would need to increase revenues more than tenfold by 2018.

Do you really want to make that bet?

Another reason why I’m giving Facebook’s IPO the cold shoulder is growth may be slowing.

Facebook’s revenue and earnings both declined in the first quarter of 2012 from the fourth quarter of 2011.  The company saw a drop off in demand from its biggest source of revenue… advertisers.  And expenses are rising fast as Facebook builds data centers and hires engineers by the dozens.

Now, the first quarter weakness may just be a temporary situation.  But do you really want to pay top dollar for a stock that is coming off sequential declines in both revenue and earnings?

The last reason I’m avoiding Facebook’s IPO has to do with CEO Mark Zuckerberg.  After the IPO, Mr. Zuckerberg will own 57% of the voting rights to Facebook stock.  In other words, he will effectively have sole control over the company.

That’s a scary proposition in my humble opinion.

Sure, Mr. Zuckerberg created Facebook and built the company into what it is today.  But I’m always worried when a company’s fate could depend entirely on the decisions of one person.

Who’s to say Mr. Zuckerberg has the qualifications to lead Facebook once it becomes a giant public company?

No question about it, the Facebook IPO is going to be the market’s biggest event of the year, if not the decade.  It will be difficult for most investors to hold off on buying shares.

But if you want to make money on Facebook shares, your best bet is to avoid chasing the stock on the IPO.  You will get much more bang for your buck if you wait for the stock to trade at a more reasonable valuation before you buy.

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Category: Stocks

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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