Facebook is scheduled to launch its initial public offering
tomorrow, but the best trade may be to avoid the stock altogether
or even to short it.
Several areas worry me about this IPO. The first is the valuations,
which are quite expensive based on the table below. Does FB deserve
to trade at such rich premiums to well established companies such
as Apple and Google?
Another problem is the momentum of their business: Revenue surged
44 percent between the December 2010 quarter and the December 2011
quarter, but net income rose only 20 percent. Meanwhile, the "cost
of revenue," which mainly entails items like servers and data
storage, shot up by 65 percent while marketing and sales costs more
than doubled. (See page 54 of the company's
Translation: Facebook is getting less bang for the buck, paying
more to get each incremental dollar of revenue.
I am no expert on the company's operations, but I'd venture to
guess that it is shelling out tons of money to host dog and wedding
pictures of everyone on the planet and failing to monetize it. The
growth on the marketing and sales line indicates that Facebook is
also hiring tons of salespeople to jam revenue in the door.
In many ways, this should come as no surprise. As a new business,
Facebook still needs to discover the right way to sell its
services. And that costs time and money.
But so far it seems that the company isn't not doing a very good
job on this front. That was the verdict by General Motors, which
last night announced that it would stop advertising on the social
This came as a major blow because GM is one of the top five
consumers of advertising in the country, with almost a century of
experience in print and on the airwaves. The auto maker is not just
any old name, but the kind of core customer that any media company
needs to have on its roster.
So why is everyone so excited about FB going public? First, we have
the banks out there beating the drum. Second, we have no liquid
market, and therefore no reality. Third, there is no incentive for
anyone to be negative on the name--at least not yet.
Say you're an institutional money manager who answers to committees
and large clients: You have to own the stock before the IPO because
if you miss a big winner, your career is at risk. If it proves to
be a failure, on the other hand, you'll have cover because all your
competitors were in the same boat.
Once the stock begins trading, it will be a completely different
matter. That's when talk is cheap and money rules. And that is
when, I believe, FB could face a difficult reality check.
The good news is that there are other new web companies that
probably make much better investments. Take Chinese
social-networking stocks like
, for instance. Both seem to have bottomed after getting hammered
in the last year, and both have reported strong results recently.
is another to consider. Unlike Facebook, its margins are expanding.
It also seems to be rooting itself firmly in the world of executive
search and professional networking, and it is increasingly trusted
by recruiters and HR departments. That kind of specific long-term
market position is exactly what Mark Zuckerberg's company lacks.
Finally, two others that have recently appeared on researchLAB are
, a maker of games for wireless devices, and
, which runs websites such as eHow. GLUU's earnings have been
strong and looks like a probable takeover candidate to me. DMD has
also had good earnings and recently rebuffed a buyout at the hands
of Thomas H. Lee.
(A version of this article appeared in optionMONSTER's
What's the Trade?
newsletter of May 16.)
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