Owning a Piece of the Largest Social Network

With over 900 million users, the world’s largest social network is set to make it’s public debut this Friday, May 18th – marking the largest initial public offering for a company within the last ten years (crushing Google’s initial IPO market cap of $23 billion.) With a valuation of somewhere between $80-$100 billion dollars, many investors are left scratching their heads and thinking “Is this too good to be true?” Well, in my opinion – yes, it probably is. Market valuation is largely influenced by general public opinion, and even though underwriters look to price the shares between $35 & $38 dollars (I’ve heard as high as $44,) there are a variety of major risk factors associated with Facebook that makes purchasing stock on May 18th less than a great idea.

Why go IPO in the fist place? To raise cash, and lots of it. And in going public Facebook now has to walk and talk like a real public company. After filing with the Securities and Exchange Commission, Facebook listed around 35 “risk factors” associated with their business model – risk factors that could substantially threaten the sustainability of the company moving forward, risk factors that any potential investor should pay attention to. Apart from the obvious reasons (Facebook is a huge source of copyright and patent infringements, viruses, malware, you name it) there are much larger issues that put a kink in the company’s colossal valuation.

One big problem – Mobile advertising, yea…Facebook doesn’t do this. With the explosive growth of Mobile advertising over the last five years (and this growth expected to continue, even increase, going into the future,) having a Mobile application that doesn’t show ads is a big problem. What’s the answer? Blast Mobile Facebook users for an ad concerning “Coor’s Light Summer Showdown” every time they log on via their smartphone or tablet? The answer is not that simple. You have to think of Facebook from a user experience perspective. Think of how annoying it is when you have to deal with pop-up ads every time you play your free version of Paper Toss – prompting you to finally pay the $1 for access to the ad-free version of the game. Facebook is no different – if Facebook turns their mobile platform into a virtual advertising minefield for the sake of bolstering revenue, the millions of users they lose each quarter will increase dramatically.

Issue number two: Zynga. Relying on any one company for a substantial portion of your revenue is dangerous, but it’s particularly dangerous if your Facebook. Zynga, the gaming masterminds behind such masterpieces as Farmville (note my sarcasm,) drives a significant amount of money for Facebook through their games – but how long will Zynga be around? Would you feel comfortable having your company dependent on a business that’s being constantly accused of stealing ideas for their games – a company that fell flat concerning it’s own IPO? No, you probably wouldn’t. If Facebook doesn’t find a way to tastefully break into Mobile advertising, to find a way to diversify it’s gaming revenue apart from Zynga, future revenues will be a very big concern.

Issue 3: Dual-Class voting of shares. For anyone who has read about the upcoming Facebook IPO, you’re probably familiar with the company’s dual class structure. In a nut shell, Facebook has two classes of shares: Class A and Class B. A share of Class B stock has 10 times the voting power as a share of Class A – this is how Mark Zuckerberg is able to own around 28% of the company’s equity but have 57% voting power (voting power that will allow him to have complete control over Facebook’s Board of Directors.) From a governance perspective, this is a big red flag for potential investors. Having control of a company in the hand’s of a single man is never a good thing – what if Zuckerberg and/or Sandberg left the company after cashing in? What’s stopping them? The idea of a Facebook without Zuckerberg at the helm is hard to imagine – it would be a company that significantly less people would invest in and embrace.

Issue 4: Facebook doesn’t have anywhere to go but down. With an 88% revenue growth in 2011, it should be obvious that Facebook will not be able to maintain this momentum in years to come. Especially in context to social media, the environment is constantly adapting – people are discovering new and unique ways to share information with one another (think of how much Pinterest has grown within the last year.) If people don’t begin to really embrace and interact with large brands on Facebook, businesses will become less and less engaged (regardless of the volume of active, daily users.)

Issue 5: IPOs rarely live up to the hype. With the exception of LinkedIn, the last few years have been scattered with the failures of social network stocks. Groupon: down 25% since its IPO. Another study found that of 19 social media IPOs of 2011, 82% were currently trading under their initial public offering. The bottom line: social media IPOs render a lot of talk, but they rarely live up to their initial valuation. Don’t let yourself be fooled by the market, IPOs are based just as much upon subjective realities as they are on the (e.g.) company’s current operating cash flow.

Do I think Facebook has the potential to be a great company? Sure. Do I think they have, from an advertising perspective, the ability to target users in new, unique ways in which Google could only dream of doing? Absolutely. Am I telling you to never purchase Facebook stock? Of course not. What I’m saying is – give the company some time. Facebook is yet to live up to its valuation, and in times like this the market has a way of adjusting past the hype and speculation, coming more into equilibrium with the company’s actual worth post IPO.

My opinion: Save yourself a few bucks and see where the company is six months from now.

 

 

 

Dustin Lewis About the author
Comments:
  • Lisa Sanner
    Reply

    Dustin – what’s your latest stock tip? You hit this one right on the money, or rather right on the not-money.

    June 20, 2012 at 3:54 pm

Leave a Comment: