5 Reasons I Avoided the Facebook IPO, and Two Alternative Plays (FB, SOCL)
Although I wasn’t high on Facebook’s IPO last week, I do think there’s some potential in the company down the road. I just don’t feel comfortable buying shares right now. It’s all about the price, and Facebook (NASDAQ:FB) has a lot of “ifs” cooked into its current price…
In a minute I’ll share a couple of ways to capture some of Facebook’s potential without plunking down for its overpriced shares. But first, let’s take a look back at why I’m not sold on its current valuation.
In a February essay, Facebook IPO: Nowhere to go but Down, I was little skeptical about possibly the biggest IPO ever. And here’s a little recap about why I felt that way:
1. Very High P/E
First of all, if Facebook’s shares were actually going to sell at their high end of around $35, that will place a nearly 100 P/E valuation on the company. I think it’s safe to say that this would give the stock maybe the highest P/E of anything trading on the S&P 500. According to Rick Summers of Morningstar, Facebook could only justify such a high valuation if “the company makes $40 billion in revenue within the next six to seven years while maintaining the same profit margins.”As I’ve written before, any slip up after this IPO valuation will cause a decrease in value.
2. Slowing Ad Revenue
My next point relates to first quarter 2012. Facebook knocked it out of the park with regards to earnings and revenue. However, those numbers were lower than the preceding quarter’s. What should be considered a red flag is that it seems the drop-off was largely due to a decrease in advertiser revenue.
3. Where Will Growth Come From?
Then there’s growth. Where will it come from? Facebook has over 800 million users that log in. Have they reached a saturation point? You can’t just say, “We’re going to take it over seas and explore more markets.” This product isn’t nicotine, where you can dump it in the Third World and continue growth. International growth can only happen where devices are accessible and the infrastructure is in place.
4. The Tech IPO Trend
IPOs over the last year, except for Zynga (Nasdaq:ZNGA) – which just stunk it up at the beginning –all follow a very distinct pattern. They all traded significantly higher at open, but then followed a downward trend. And this is where it gets interesting. Each and every stock that follows this trend reverses to post gains near 50% in a short period of time.
|Company||Ticker||% Fall||% Rise|
Groupon later followed suit with a 50% fall from its high – only to see it rise 54% from that low in early December 2011.
5. I Don’t Have a Swiss Bank Account
Finally – and most importantly – I’m not rich. If you think you’re going to buy Facebook shares right from the start, it ain’t happening. Accredited investors are those with a net worth of more than $1 million (excluding their primary residence) or an annual income over $200,000 for the past two years can buy shares of private companies at online marketplaces such as SharesPost and SecondMarket. (Trading in shares of pre-IPO Facebook at both sites halted on March 30, at the request of the company, so that it could set its IPO price range.)
Those initial shares are reserved for the venture capitalists, bankers, employees and Mr. Zuckerberg. Of course, you can try, and you certainly get in on day two or so, but at what, an inflated price?
How to Make An Alternative Play
Because of the way Wall Street works, the average investor needs to consider alternative ways to take advantage of the company going public. And financial advisers and planners have figured out indirect ways to be part of the Facebook action.
1. Mutual Funds With Facebook Exposure
One of these means for regular investors to join the party is by investing in mutual funds that own slices of Facebook. The list is fairly large.
T. Rowe Price (Nasdaq:TROW) has a group of funds that own Facebook, including the $30-billion T. Rowe Price Growth Stock Fund (PRGFX), with a 0.7% position. Several Morgan Stanley (NYSE: MS) Investment Management funds also own the Internet firm, including the $1.7-billion Morgan Stanley Focus Growth fund (AMOAX), which has a 3.6% holding. Fidelity Investments says more than 30 of its funds have invested in Facebook.
Something new and interesting on the scene is the Global X Social Media Index Fund (Nasdaq:SOCL). SOCL made its debut late last year. Facebook is not yet in SOCL’s lineup. However, SOCL is home to companies like Zynga, Google (Nasdaq:GOOG), LinkedIn (NYSE:LNKD) and plenty of well-known foreign social media firms
You better believe that Facebook will very soon become one of SOCL’s holdings. And with the $100-billion valuation for Facebook, it could be its largest holding. So you can play Facebook with an ETF pretty soon and with a heavy amount of exposure to the company.
2. Invest in Related Companies
Another option, says financial adviser Robert Russell in Dayton, Ohio: buying shares of publicly traded companies that create apps for Facebook; including social gaming app developer Zynga Inc. and SNAP Interactive (OTC: STVI.PK), which has created a popular dating app. Mr. Russell says more investors could pile into these companies if Facebook’s stock takes off. “You can play the trickle-down effect coming from Facebook,” he says.
You have to believe that Zynga will capitalize on the IPO. If you’re on Facebook, you’ve probably been saturated with “Mob Wars” or “FarmVille” requests to the point of absolute annoyance. Well thank Zynga for that, because it’s the company behind those games and several others.
Zynga has already been mentioned as a possible takeover target for Facebook. After all, Zynga accounts for 12% of Facebook’s revenue, according to Benzinga. Zynga’s current market value is about $9.4 billion, even if that doubles, Facebook could easily buy it after the IPO.
Believe me when I say I’m not down on Facebook. I just don’t feel comfortable with the valuation in regards to the IPO. I’ve just seen the “herd” go crazy on too many occasions. But no matter what I say, this stock is going to be a popular one. So do what you can to profit from it while limiting your exposure to the volatility.