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Facebook – Buyer Beware!

Sigma Investment Counselors

May 21, 2012

On Friday, May 18th, Facebook began its life as one of the most anticipated and celebrated initial public offerings (IPO) in history. Due to unprecedented demand and limited shares offered in this initial offering, the stock was priced at the high end of inflated expectations.

There is much to like in the Facebook story. From very humble beginnings in 2004, Facebook has quickly grown such that it now boasts 900 million active users and is perhaps the most visited website in the world.

Yet, a great company with a bright future does not necessarily translate into an attractive investment, particularly in the short run. This may very well be the case with Facebook. Once the hype surrounding the IPO subsides, investors are likely to return to their senses and begin to value the company on the basis of their current and future earnings stream and not on emotion.

Facebook’s challenge, and biggest opportunity, is to find a way to insure that Facebook retains its popularity and find a way to monetize its outstanding Rolodex. During the interim, the company’s revenue stream in 2011 was less than $4 billion resulting in net profits substantially smaller than this amount. Yet, the company’s current market value is estimated at over $100 billion. To justify such a high market value, investors are betting that Facebook will be able to increase its advertising and other revenues on a sustained basis over many years, a feat that is not as easy as some may believe.

I would submit that a great deal of hot money was chasing this IPO, hoping to make a quick profit following its debut. Interestingly, the investment bankers priced the deal such that the company was able to maximize the value for the few shares that it released to the public, leaving little upside for those that participated in the initial offering.

Now that we are in the second day of trading, the stock began trading slightly above its IPS price of $38 per share. Now, at midday, the stock has begun to fall and is currently trading under $34 per share. This is not what many initial investors were hoping for and I would not be surprised if the stock falls even further as disgruntled investors head for the sidelines.

Longer term, I would be open to the possibility of owning Facebook common stock. But if you are not in it for the long term, “buyers beware”.

Your thoughts are welcome.

Christopher J. Kress, CFA

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