You’re A Patsy If You Buy Facebook’s IPO

Facebook recently announced they are going public. Mark Zuckerberg plans on making approximately $40 Billion from the IPO. While I do think Facebook is a great company and amazing success story, you have to be a patsy to invest in them.

The popular saying in poker is “if you don’t know who’s the patsy at your table, then it’s you”, applies to buying Facebook (FB) at this stage of the game. Take it from someone who worked for a start up during the dot bomb days. Commerce One (CMRC), or Commerce None as I aptly call them since they are out of business, was one of the biggest IPOs during the 90’s. I’m not saying Facebook is the same as Commerce One, but implying who are the ones making money by going public.

The ones making money off Facebook are the ones who had an early stake in the company. It’s the founders, early investors, employees, and underwriters who are minting money. They are cashing out of their investment, and who could blame them. The social media space is currently very hot with investors.

It’s been estimated Facebook will be worth $100 Billion at the time of their public offering. Is Facebook really worth 100 times, taking into account their last year revenue of $1 Billion? Let’s even double it and assume this year they grow 100%, and generate $2 Billion annually, or 50 P/E ratio. Is Facebook worth that amount?

As I’ve mentioned in a previous post, there are really only two factors when considering investing in a company. To recap:

  1. Is the stock cheaply priced?
  2. What’s the prospect of future growth for the company in the next five to ten years?

Facebook definitely fails with test #1, and its future growth is also questionable. Though I do think it will grow faster than the average S&P 500 company. I do not think it’s worth 100 times current annual earnings. Mind you, in the short term the stock could do very well. Mr. Market can stay irrational for a very long time. What I’m saying is the fundamentals aren’t there to support the price.

Henry Blodget of Business Insider (yes the same guy who stated Amazon was a $300/share stock in the 90’s), has a fair and balanced article on what the real valuation of Facebook should be.

Facebook revenue is primarily adverting based and relies on a very fickle audience. Anyone remember MySpace? Facebook is the AOL of this era. Facebook’s user base growth has been outstanding where it’s been reported over 600 million users. The problem is at that huge base it will likely not grow much more. Instead Facebook must focus increasing the revenue per user, which isn’t an easy feat.

So while I think Facebook is a great company, and personally use the service myself, you will not find me investing in it. That time has come and gone, and you should have been done via the secondary market a few years ago. Employees of Facebook were selling their shares on some of the private exchanges. It was a very “public” company when still being private. So if you invest in Facebook now, you’re the patsy. Facebook is a trade, not an investment at its IPO price. There are currently better tech companies with well established histories and at much cheaper valuations.

Readers: What do you think of Facebook as an investment? Do you think my assessment of Facebook is wrong?

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Reader Comments

  1. says

    I think a lot of people are looking at the hype. They see a few other online properties doing well and assume that FB will be a great buy. Problem is – who knows?

    Future growth should be built into the price, right? So it would have to do even better than the price suggests (and who knows what the price will be by the end of the IPO day?).

    Another question is do we really understand where their revenue is coming from? Can we trust that for the future? It’s interesting you mentioned MySpace since they have actually been growing again in the last few months. Add to that sites like Google+ and Pinterest and who’s to say what the future holds for Facebook?

    I’d much rather deal with a stock like Apple or Amazon where they have shown profit and growth for years. FB could prove the naysayers wrong but I’d rather not stomach all the ‘ifs’ with them right now.

    • says

      Eh I’m not a fan of Amazon either. While they are growing, their profit margin sucks. As I’ve publicly stated I’m still very much a fan of Apple even at today’s price.

  2. says

    I think it’s funny how a company can be worth $100 billion with less than 1% of that being tangible assets. I would find it very hard to invest my hard earned dollars in a company that relies on traffic and advertising as it’s sole method of revenue..

    • says

      What about Google? Or say TV, radio, or newspapers? You wouldn’t invest in those types of companies either? All base their business on eyeballs.

      I see no issue with Facebook’s revenue model, just the valuation it’s held at. If Facebook’s P/E were around 30-40 I would seriously consider it, but not 100. There are much better companies to invest in at cheaper valuations with long profit histories.

  3. pcfllintent says

    They won’t make it out of IPO, they will be sued about their “new” advertising plans. On top of already pissing off their user base and the advertisers that pay for their profits now who have be dropping because of their lack of ROI. After all is said and done, the public won’t want a piece of FB and will move on.

  4. says

    The mistake I think a lot of people will make with Facebook is their memory of when Google went public and then rose up and up. However, I have to agree with your assessment. A PE of 100 is too much for me. Although it is popular for now, Facebook has yet to diversify and prove that it can last another 5, 10, or 20 more years.

    • says

      Google’s IPO because of the way they wanted to go public wasn’t priced correctly. So this left a lot of profit potential for investors, while a lot of money was left on the table by Google. Facebook on the other hand will be fully priced the first day of trading.